How Low Appraisals Work
First of all, some people think you will automatically get an appraisal when you buy real estate. However, you only need an appraisal when you are getting a loan. The lender needs to know the property's value. Meaning - appraisals aren't only about money - sometimes they are about repair work as well.
The loan amount is based on the appraised value. The lender will not loan an amount higher than the appraised value.
In our hot real estate market, where people are outbidding each other to win the house - the offers might escalate the price above the appraised value. Of course, you won't know that until later in the process. In the moment, you are just estatic that you've won the offer in this competitve market.
During the lending process, the lender will put in an order for an appraiser to view and evaluate the home. The appraiser produces a report that real estate agents don't normally look at. If a home is valued at the price that is needed for the loan, there is no issue and no reason to review an appraisal report. Everyone can breathe a sigh of relief, and move forward with the transaction.
However, if the apprasier evaluates the home and decides that the value is less than the sales price, that's a different story.
Here's the basic process:
Buyer's agent notifies the seller's agent of low appraisal.
The seller can respond several different ways:
The seller can agree to the lower sales price.
The seller can ask for a reconsideration of the value/get the home re-appraised (lender must approve).
The seller can propose a reduction in price (often times, seller proposes that the seller and buyer split the cost of the low appraisal).
The seller can reject the low appraisal (essentially rejecting the entire deal).
The buyer can respond several different ways:
Give notice to terminate the agreement (and they will get their earnest money returned).
Waive financing contingeny (oftentimes if seller doesn't want to reduce the price, the seller asks the buyer to pay the full difference and asks the buyer to waive the financing contingency).
Accept reduced purchase price (where the seller and buyer usually split the cost of the low appraisal - not always 50/50 - that part is negotiable).
Let's use an example.