What do you do when you get a low appraisal on the house you are buying/selling?
You are buying your dream home and super pumped up about everything. You are already organizing the way you are going to lay out the furniture in your new “open floor plan” entertaining paradise. The back deck is going to get completely redone with your brand new wicker furniture you are just about to buy online. You see that extra bedroom being painted pink to welcome the new baby girl that will arrive in 3 months 2 weeks and 4 days. The last thing on your mind was a low appraisal…
You are selling your house thankfully after a few years of misery. A couple of years ago your house was severely underwater, but now that values have crept back up you can finally sell it for what you owe. You ran out of space 2 years ago when junior came along and the toys are piling up. You know you are not, but feel like a hoarder. Your next dream home is in clear sight. Great neighborhood, schools, and short commute to work. Totally upgraded and you can just move right in and plop on your couch just in time to watch the Cubs, Bears, White Sox, Bulls, or Blackhawks game national anthem. The last thing on your mind was a low appraisal…
Your lender calls and says I’m sorry, but you had a low appraisal on your upcoming home purchase.
What? What do you mean low appraisal? Total devastation because what do you do now?
This can and does happen everyday. Once a home buyer goes under contract to purchase a property and they fully apply for a loan, their lender will hire an appraisal on the property. This is done to make sure that the the loan amount the bank is lending to the borrower for the property being purchased does not exceed what the property is worth.
It makes complete sense. Who wants to lend money on an overvalued property? So what do you do if you get a low appraisal?
Here’s what you do…
In your purchase contract you should have a mortgage contingency that makes the purchase of the property contingent upon a buyer securing financing for x % of the purchase price. So if John Doe is putting down 5% on a $100,000 property, he is taking out a loan of 95% of the value of that property or $95,000. If he was putting down 10% on the property his loan would be 90% of the value of the property or $90,000.
The mortgage contingency in the typical real estate purchase contract will state that the purchase contract is contingent upon the buyers ability to procure financing. The buyer will write into the contract how much money they are borrowing against the purchase price known as loan to value. The financing is contingent upon the property appraising out at the purchase price or above.
Let’s walk through that in English:
John buys a $100,000 property and is putting down 5%.
The property appraises out at $93,000, but his purchase contract is for $100,000.
The bank will only loan John 95%(since he is putting down 5% of his own money) of $93,000 or $88,350.
If John wants to buy this house he has two options because of the low appraisal.
1. He can come up with the extra $7,000 in addition to his 5% down payment.
2. He can go back to the seller and see if the seller will take a $93,000 sales price since the appraisal came in low. The mortgage contingency made the purchase contract contingent of John getting a mortgage of 95% of his purchase price. Because of the low appraisal, John cannot receive financing for 95% of $100,000, but he can obtain financing for 95% of $93,000 (the appraisal amount).
This is what the mortgage contingency looks like in the standard 6.0 contract that is typically used in the Chicago real estate market.
Those are really the only two option should you find yourself in a low appraisal situation. Here are a couple tips to make sure a low appraisal does not happen to you.
1. Don’t overpay for a house
2. Do your homework
3. Do not buy without an experienced real estate agent(who will take care of #1 and #2)
4. Just hire the Chicago Real Estate Dude and you will never have to worry about any of this :).
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