Blog
Handling an Appraisal Gap
May 25, 2023
An appraisal gap describes the difference between the sales price and the lower amount of the appraisal required by the mortgage being obtained by the buyer. It becomes an issue if the seller is not willing to lower the price or the buyer is not willing to pay the difference in cash.
Looking at the issue from the seller’s perspective, “if the buyer wants my home and he can’t get the loan he wants, he’ll have to make up the difference in cash.” The buyer might have a different view like “If an independent appraiser can’t justify the price, I’m not going to pay more than appraised value.”
- Pay the difference in the appraised value and the purchase price in cash.
Solution – Assuming the buyer has adequate cash reserves and is willing to pay above appraised value, this will satisfy the lender. - Decrease your down payment percentage to apply toward the appraisal gap. It may trigger mortgage insurance which will increase your payment.
Example:
$400,000 Sales Price with 20% down payment of $80,000; Home appraises for $390,000
Possible solution … buyer could take $10,000 of the $80,000 he was going to use for the down payment and make up the gap. That only leaves him $70,000 which is a good downpayment for this size home, but it may require that he pay mortgage insurance because the loan-to-value is more than 80%. - Renegotiate the contract with the seller. Assuming both parties are willing to negotiate on the terms, the seller could lower the price to the appraised value, or any other number of possibilities.
- Include an appraisal gap clause – “Buyer and seller agree that if the appraised value comes in lower than the purchase price, buyer agrees to pay up to $XX,000 above appraised value, but not exceeding the purchase price.“
An appraisal gap clause addresses what the buyer is willing to do within the parameters included. It provides limited comfort to both the seller and buyer to address the issue of the home appraising for a lower amount than necessary. This clause provides a way for the buyer to compete in a seller’s market. - Terminate the contract.
Appraisals can be a confusing but necessary part of the process when the buyer needs a mortgage. I’m available to answer any questions and share our experience with you. My goal is to be your source of real estate information.
Protect yourself with a new construction inspection
May 8, 2023
Builders of new homes offer or are required to warrant their work for a specified period. Municipal inspections are generally required during different stages to “ensure the life, health, safety, and welfare of the public” but even if something is missed, the ultimate responsibility for building to code belongs to the builder, even if the municipal inspector misses something.
There are four basic stages of residential construction including:
- The foundation stage begins with excavation, footings, foundation walls or slab, waterproofing, backfill, compaction and underground rough plumbing and electricity. Municipal inspections are done prior to pouring the foundation while items are visible.
- The framing stage includes the wood or steel framing, exterior walls and roof sheathing, exterior trim and siding, windows, doors, and roofing. Depending on the municipality, there could be inspections of the rough framing separate from the roofing.
Next in this stage comes rough plumbing including water, waste, and vent piping, rough electrical, rough mechanical, ductwork, wiring, and electrical panel installation. Municipalities will usually inspect plumbing and electrical separately. - The wall insulation and drywall installation are done and inspected depending on the municipality before tape and texturing are done.
- The final stage of construction includes flooring, cabinets, millwork, countertops, tile, mirrors, electrical trim, plumbing trim, and mechanical. Some builders will not install appliances and HVAC until the last stage to protect against theft. Municipal inspections are made in the final electric, plumbing, and mechanical.
A “Final Inspection” is done after all the periodic inspections have been completed and passed.
Defects that manifest themselves during the warranty period are the responsibility of the builder. Unfortunately, some things may go undetected until after the warranty expires leaving the repair expense as the sole burden of the buyer/owner.
A safeguard that the purchaser will not be out of pocket for repair expenses is a home warranty which shifts the liability to the warranty or service contract company. This is a negotiable item that can be paid for by the builder or the buyer. However, this warranty will have a time limit on it and to continue the coverage, the buyer/owner will have to renew it by paying the additional annual premium.
One more safeguard for the purchaser is to hire their own inspector, to conduct periodic inspections during the different phases of construction. Unlike an inspection made on an existing home, the inspector will have to visit the site multiple times during the process. For that reason, constructions inspections are more expensive.
When hiring an inspector for new construction, ask at what stages do they inspect. A typical new construction inspection might be at the end of the foundation stage, another at the end of the framing and rough plumbing, electrical, and mechanical, and the final inspection after the home is completed.
A provision allowing a buyer to hire their own inspector for periodic inspections should be included in the sales contract. Your agent can not only help you get that included but assist in negotiation of any issues that arise because of the periodic inspections. If you value this extra level of protection in the purchase of a new home, it is important that you have your agent first accompany you to the models so they will be registered as your agent.
A Lesson on Housing from the 80’s
May 5, 2023
Doing nothing may be a lot more costly than doing something. With rates twice what they were in 2021 and the first half of 2022, many buyers are sitting on the sideline. For some, it has to do with not being able to afford the home they want at today’s mortgage rates and for others, it is not willing to accept that the low rates that were available are not only gone, but may never be available again.
In the late 70’s, rates were around 10% and in the early 80’s went up to 18%. Interestingly, many buyers went ahead and purchased at those record level highs and refinanced a few years later when rates came down. By the end of the decade, prices had continued to increase so that buyers had a significant equity in their home.
Tenants who waited for the rates to go down didn’t see savings because the price of homes had gone up. More importantly, they missed the opportunity to build equity in their home through amortization and appreciation.
If you purchased a $400,000 home today on an FHA loan at 6.3% for 30 years, your total payment with taxes, insurance, and mortgage insurance premium would be about $3,459 a month.
That payment could save you a little bit if you were paying $3,500 for rent. However, when you consider the monthly appreciation, assuming a 3% annual rate, and the monthly principal reduction due to amortization, the net cost of housing would be $2,229. You would be paying $1,270 more each month to continue to rent which would amount to over $15,000 in one year alone.
That loss would be about twice the amount of the down payment to get into the home. Furthermore, in seven years, at the same 3% appreciation, your $7,500 investment in a down payment would grow to $138,000 in equity in seven years. If the appreciation is greater than that, the equity would be much more.
You’re going to be paying rent to live in a home; you might as well benefit from the equity buildup from amortization and appreciation that is only available to the owner.
The benefit of acting now is that sales are down which are affecting prices, although not dramatically. When the Fed gets a handle on inflation, and interest rates do moderate some, more buyers will be in the market and supply and demand will again cause prices to rise. Then, you can refinance to a lower rate but your investment in the home will be at a lower basis.
To run your own numbers, use our Rent vs. Own. If you have questions, call me and I’ll explain how to use it and what to expect for the home you’d like to have.