What is gap insurance?

appraisal valuation

I had clients make an offer on a property last weekend where the seller actually made a counteroffer because of the buyer’s letter. One of the conditions of the counteroffer was full gap insurance coverage.

What is gap insurance?

In this case it’s actually the same thing as an appraisal guarantee, which has become a big deal in the insanely competitive market this year, with multiple offers often going W-A-Y over list price. It covers the question of what will happen if the appraisal value comes in lower than sale price… and sellers are often making it a condition of accepting an offer.

Today, buyers may offer to pay up to $50,000 (or some other number) to bridge the gap if the appraisal comes in low. That helps, but full gap coverage is what sellers tend to be looking for these days.

In other words, if the appraisal comes up short the buyer guarantees that they will not cancel or negotiate a lower price with the seller. Instead, if the appraised value is lower than the purchase price the buyer will make up the difference between sale price and appraisal value. They will do whatever the lender requires to move on to closing.

What does that mean in $?

For example, if your purchase agreement was for $500,000 and the appraisal came in at $470,000, you would have to come up with an additional $30,000 cash at closing to cover the gap in addition to your down payment.

$470,000 would become the new basis for the mortgage, and if you are putting 20% down, you would pay 20% of $470,000 ($94,000) instead of 20% of $500,000 ($100,000) so you save a little there.

Appraisals more often come in at value than below, but you still have to be prepared to bridge the gap if necessary if you include an appraisal guarantee (aka gap insurance). So many offers help support the value. Banks want to know if they would be able to sell the house again at sale price if the buyer defaults.

If the appraisal comes in low you have the option to appeal. I actually had that happen to a client recently who made their offer subject to full appraisal gap coverage… a condition the seller insisted upon for acceptance of their offer. We were able to present a case for using another property instead of the one used in the original appraisal as the primary comp… it was a more recent sale, and it required the fewest adjustments. We were all both excited and relieved when the large appraisal gap was erased by a revised appraised value at sale price!

Sharlene Hensrud, RE/MAX Results – shensrud@homemsp.com

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I love what I do! Highly insightful, analytical and creative, there is nothing I love more than helping you find the right solution for your real estate transition. My mission is to serve my clients with honesty and integrity, exceeding their expectations in service and support… and to help others by donating a portion of every transaction to Habitat for Humanity.

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