Purchasing a home in a competitive market can present many challenges. It’s important you know every negotiating tactic at your disposal, in order to beat out your competitors and win the deal. So today we’ll discuss one of the most important tools in the toolbox – guaranteed cash above appraisal, or as we also call it, appraisal gap guarantees.
We’ve been in a strong seller’s market for several years now. And multiple offers are still the norm throughout much of Hampton Roads. There are many factors that go into writing a winning offer on a home. When you go to write an offer on a home you love, you may need to do everything you can to win the deal, because more often than not - and this shouldn’t come as a surprise – sellers want to get the most money they can for their home. That’s where cash guarantees above appraisal come in.
Let’s start with what sellers want. Sellers want deals with the highest probability of closing at the agreed upon terms of the contract, particularly the agreed upon sales price. The fewer variables, the less risk, the higher chance of that happening. So sellers are often inclined to take the offer that gives them the best chance at closing without having to adjust the final terms, and some deals are riskier than others.
You’ve heard the saying before, cash is king! Well, in real estate, a large part of the reason cash is king is because there’s usually no appraisal involved in all cash transactions, meaning the agreed upon sales price will generally be the final sales price, and not subject to the opinion of an appraiser, who may value the home below the purchase price. You see, whenever you purchase a home with a mortgage, the bank is going to send an appraiser out to the property to value the home, and in a rising cost environment, it’s not uncommon for the appraisal to come in low. Afterall, they’re basing their appraisal price on comps that may have sold several months ago when prices were a little lower, and we normally get our list price based off the same comps the appraiser is going to use, so it’s common for both listing agents and sellers to assume the appraisal should come in somewhat close to the list price.
The important thing here is that the bank is not going to provide you with a loan for more than the appraised value. That’s regardless of loan type or down payment, so in a standard transaction if the appraisal comes in below sales price one of three things needs to happen; either the sales price needs to be adjusted down to the appraisal price, which can cost the sellers thousands of dollars, or the buyer needs to make up the difference with cash. Or the third option would be a combination of the two, finding some middle ground where the price is adjusted and the buyer still brings some cash. And That’s where cash guarantees above appraisal come in.
A cash guarantee above appraisal, or appraisal gap guarantee as we also call it, is when you indicate in your offer to the seller that you’re willing to make up the difference between the appraisal price and the agreed upon sales price, or at least a portion thereof, by bringing extra cash to closing, above and beyond your down payment and closing costs. This tells the seller that the price that was negotiated has a high probability of closing at that price, and strengthens the terms of your offer considerably. Afterall, that’s what sellers want to hear. They want to know that the deal they accepted is the one that they’ll go to closing with.
So let’s run through a few scenarios so you can get a better understanding of how this works. For the sake of these examples, we’re going to leave out closing costs. Just know you still need to have the money for your closing costs on top of your down payment, and your appraisal gap guarantee.
OK, Let’s say you’re planning to buy a home listed for $400,000. It’s a competitive situation, so you go over list price by $20,000 and you have the winning offer of $420,000 with a $20,000 cash guarantee above appraisal. You’re planning to put 20% down, which in this case is $84,000 as long as the appraisal comes in at $420,000 or higher. But in this case, it comes in right at list price of $400,000. Now the bank is only going to base your loan of the appraisal value of $400,000, so instead of putting $84,000 down, you’ll now be putting $80,000 down towards your mortgage, along with another $20,000 to make up the appraisal gap, so you’ll need to put $100,000 down total to close on the purchase. In this situation, you still get your house, but you’re out $16,000 more up front than you would have been at $420,000. But on the bright side, you got the house for less and the seller is still very happy because they got the sales price you agreed to.
Ok, so now let’s take the same transaction, but instead of the appraisal coming in at $420,000 it comes in at $410,000. In this scenario you’ll now be putting $82,000 down and bringing an extra $10,000 to the table to get to $420,000. The way we generally write these clauses is that you’ll make up the gap that gets you to, but not above the agreed upon sales price. So in this case instead of having to bring the full 20 thousand, you only have to bring 10. And again, seller still gets the agreed upon price of $420,000.
Scenario number three: Same terms of the contract, but oh no, the appraisal came in way low at $390,000! In this case, the sellers would have to agree to lower the sales price down to $410,000 because you’ve already said you’re willing to pay $20,000 over appraisal price. Just because they’ve agreed to accept the terms of your contract, doesn’t mean they have to lower the price if your cash guarantee doesn’t make up the full difference. They could, theoretically, kill the deal. Assuming they do agree to adjust the sales price to $410,000 you’ll be putting $78,000 down along with $20,000 more to make up the gap. So you’re in for $98,000 at closing, but the sellers lose 10 grand of potential profit.
Now, there are certainly other ways to do this. You don’t need to offer the full price difference. You can offer a purchase price 20K over list price, but only offer a 5 or $10,000 appraisal gap guarantee. That’s a whole lot better than nothing, and will absolutely strengthen your offer. Or you could go the other way. In our second scenario, I mentioned we usually cap the guarantees at the agreed upon sales price, however that’s not a strict rule. You could leave it open ended and offer to pay X amount over the appraisal no matter what it comes in at. That’s less common, but would certainly put you in a great position to win the deal.
As great of a strategy as cash guarantees are, you have to have the money to do it. And that’s where this can be a limiting factor for many buyers. Let’s go over, real quick, who may not be able to take advantage of this strategy.
First is our first time, low money/no money down borrowers. Many young people buying their first home just aren’t going to have the funds on hand to implement this strategy, especially if they haven’t been in the work force long enough to be able to tap into a 401K or other savings plan. Second, are our military VA loan buyers. The VA loan is a no money down loan, and many buyers who are using this loan type are trying to keep it that way, so the idea of guaranteeing cash above appraisal just isn’t going to be an option. In quickly rising markets, even in a huge military area like Hampton Roads, we often see VA loans used at a far lower rate, because they can’t compete with conventional loans with guarantees. But If you’re a VA buyer or a first time home buyer, reach out, we do have ways to help position you to still be competitive. The third buyer who may not be able to implement the cash guarantee, and this one may come as a bit of a surprise, is someone who needs to put 20% down, but doesn’t have more than that on hand. Putting 20% down allows you to avoid paying mortgage insurance, and can significantly reduce your monthly payment. If the cash guarantee forces you to only put 10 or 15% down, then you may not want to do the deal at all. Or you could, potentially, not even qualify for the loan without the 20% down. So Oddly, someone who is only planning to put 5 or 10% down, but has the extra funds is in a better position to offer an appraisal gap guarantee than someone who has to put 20% down, and has the funds, but nothing extra. In fact, I recently had a deal where this exact scenario played out. Fortunately, my client was the one putting 10% down, and had an extra $10,000 for a guarantee above appraisal, so we won the deal.
Well there it is, the cash above appraisal buying strategy. This is absolutely one of the strongest and most important strategies you can implement when purchasing a home in a competitive environment. And I know that the idea that you may have to come out of pocket with the extra cash is never fun, or you may feel like you’re “overpaying”, but it can often be a requirement in order to lock down a home for you and your family, so it’s best to know that it’s an option, and one to consider using when writing an offer. If you’re a ways out from buying, you never know what the market will look like, but it’s smart to start planning for it now that way if it’s a necessity, you’re fully prepared to go out and get your dream home!
If you have any questions, or are interested in make a move to the Hampton Roads/Williamsburg area, please call, text, or email any time!
