Appraisal Gap Contingencies Have Returned in the Early Spring Market

Appraisal Gap Contingencies Have Returned in the Early Spring Market
Written by: Eddie Cohen – Licensed Mortgage Loan Officer – NMLS #437457

In today’s competitive real estate market, buyers are once again seeing appraisal gap contingencies make a comeback. With rapidly rising demand and tighter inventories, buyers sometimes find themselves in bidding wars where the contract price exceeds the appraised value of the home.

What is an Appraisal Gap Contingency?

An appraisal gap contingency is a clause that allows buyers to agree to cover a shortfall between the appraised value and the agreed-upon purchase price, up to a pre-determined limit. This extra assurance can help secure a property by giving the seller added confidence in the offer, even in the event of a low appraisal.

How Mortgage Insurance Steps In

For buyers who don’t have substantial cash reserves, especially those making a lower down payment, bridging this gap can be challenging. Mortgage insurance offers a solution by mitigating the risk associated with lower appraisals. Typically, buyers putting down 20% or more can avoid mortgage insurance altogether, while those putting down as little as 3% are required to carry it. With mortgage insurance in place, lenders can increase coverage without requiring even more cash at closing, making it easier for buyers to compete for properties even when the appraisal comes in short.

Payment Examples

Consider a home priced at $300,000. Below are two hypothetical scenarios, assuming a 6.5% interest rate for a 30-year fixed mortgage. Note: The figures below are illustrative and intended for educational purposes; actual rates, mortgage insurance premiums, and monthly payments may vary based on individual circumstances and lender requirements.

Scenario: 20% Down Payment

• Purchase Price: $300,000
• Down Payment: $60,000
• Loan Amount: $240,000
• Mortgage Insurance: Not required
• Monthly Principal & Interest Payment (approximate): $1,517
• Appraisal Gap Coverage: The buyer agrees to cover up to $25,000 in the event of a low appraisal

Appraisal Result: $275,000

How does the low appraisal impact the numbers?
Originally, the buyer planned a 20% down payment on a $300,000 home—providing $60,000 in cash and financing $240,000—resulting in an 80% LTV (loan-to-value)that avoided mortgage insurance. However, when the appraisal comes in at $275,000 (i.e. $25,000 below the contract price), the situation changes as follows:

• The buyer’s total cash contribution remains $60,000.
• Instead of all being considered a traditional down payment, the $60,000 is now effectively split into $35,000 of actual cash down and $25,000 as agreed-upon appraisal gap coverage to bridge the difference between the contract price and the lower appraisal.
• Because the lender bases the loan on the appraised value of $275,000, the LTV becomes $240,000/$275,000—roughly 87.3% (or about 88%).
• This higher LTV triggers the requirement for mortgage insurance, which in our example increases the monthly payment by approximately $30—from about $1,517 to $1,547.

Importantly, in this scenario the buyer does not bring in extra cash beyond the original $60,000, nor do they borrow additional funds. Instead, the originally planned cash is reallocated between a smaller effective down payment and gap coverage, resulting in a higher LTV that necessitates mortgage insurance.

Adjusted Scenario (Post-Appraisal)

• Purchase Price: $300,000
• Appraised Value: $275,000
• Effective Cash Down Payment: $35,000
• Appraisal Gap Coverage: $25,000
• Loan Amount: $240,000
• Mortgage Insurance: Required (at approximately 0.15%*)
• Monthly Principal & Interest (including mortgage insurance, approximate): $1,547

What These Numbers Tell Us

In this example, the buyer was able to make a competitive offer while only facing a modest increase in the monthly payment—about $30 more—without needing additional cash at closing. Although the purchase contract was for $300,000, the appraisal came in at $275,000. By agreeing to cover the $25,000 gap, the buyer aligns the effective purchase with the appraisal value while still securing the home. The added cost of mortgage insurance is the trade-off for maintaining competitiveness in a tight market without requiring a larger upfront cash contribution.

Conclusion

The resurgence of appraisal gap contingencies reflects current competitive market dynamics. Whether you’re a buyer with significant cash reserves or relying on a smaller down payment, understanding how to leverage mortgage insurance is crucial. By using mortgage insurance not only to secure a lower down payment but also to help cover any appraisal shortfall, buyers can maintain their competitive edge while managing liquidity effectively. This evolving strategy underscores the importance of partnering with experienced lenders and real estate professionals who understand the nuances of appraisal gaps and mortgage insurance options.

If you are interested in speaking to a licensed loan officer in Ohio, Kentucky, or Indiana – give me a call at 513-365-4402 – or email at eddie@cohenmortgage.com