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An appraisal gap is the difference that occurs when a buyer’s offer is higher than the actual appraised value of the property (which is usually the amount the bank will loan for the home) that they are contracting to purchase. It is an issue that is currently being experienced in the hot and highly competitive Colorado real estate market and experienced by buyers where there are many more prospective purchasers than inventory that is available for sale, and where bidding wars and other aggressive purchase offer tactics are being used.
An appraisal is based on recent comparable sales, or “comps”, but in the current housing market, these comps are not able to catch up with demand – what comparable homes were selling for 3 to 6 months before may not account for the increased buyer demand. Therefore, currently these bidding wars and appraisal gaps are now coming standard with many offers to purchase a property. If a prospective buyer cannot come up with these additional funds to make up the difference, they are often closed out of competing for a property.
In order to compete, many buyers will have to promise in their offer to purchase that they will cover part or all of the appraisal gap, in cash, and usually before they even know how much that gap will be. We have heard of reported instances where homes have sold for as much as $100,000 over the asking price and appraisal, whereby the buyers were then obligated to come up with a very significant appraisal gap in order to get the property.
An appraisal gap can be a very complicated and expensive proposition, so make sure that you get advice from a licensed real estate agent or attorney before considering covering a potential appraisal gap.
Source: https://dre.colorado.gov