A valuation gap occurs when the value of the home is lower than the price the buyer agrees to pay. This is a common challenge in the competitive housing market, with about 8% of home valuations below contract prices.
This is particularly common in real estate markets such as Los Angeles, California, Austin, Texas, and Chicago, Illinois. The buyer is usually responsible for covering this difference, as the lender evaluates the base loan amount in the valuation, not the purchase price. This Redfin guide explains why appraisal gaps occur and how buyers can navigate effectively.
What is the rating gap?
A rating disparity occurs when the value of the house is lower than the price you agree to pay. This does not automatically close the transaction, but it can complicate things. You may need to cover the difference from your pocket or renegotiate with the seller. If you don’t agree with the solution, you may lose your home.
>>Read: Serious Money: What is it and how much should you pay?
Why does there occur a gap in ratings?
There are several common reasons for creating valuation gaps, especially in today’s competitive housing market.
High competition: In a competitive market, buyers often offer more than the value of the home, which can lead to a gap. Prices rise rapidly: Prices rise rapidly in hot markets, but ratings rely on older sales data that may not reflect the latest trends. Homes with Special Upgrades: If your home has a custom feature that doesn’t have any other homes nearby, it can be difficult for the rater to find a fair comparison. Recent sales nearby are limited: In neighborhoods with few homes for sale, there may not be enough recent data to support a high rating. Emotional bid: It is common to fall in love with a home, leading the buyer to attach and offer more than its value.
How does the rating gap work?
Imagine you find your dream home and make a $400,000 offer. However, the rating is at $380,000. Your lender is based on the loan amount on the valuation, so they will only fund 80% of the $380,000 for the $400,000 you agree to pay. This means you will need to cover the $20,000 difference yourself or negotiate with the seller to lower the price.
The valuation gap can put a financial burden on buyers, especially if they are not budgeting for this unexpected cost. If you can’t make up for the difference, you could lose your home or put serious money at risk if you abandon certain protections.
However, if you are paying all the cash, or if your home is valued above the offer, you will not face a rating gap.
How the Home Evaluation Process works
Mortgage lenders only raise funds up to the value of the home, so when they make an offer, they order an valuation to confirm the fair market value of the facility. Most lenders need it to make sure the price you are paying is not higher than the actual value of the home. This protects both buyers and lenders.
Real estate valuations are important as they affect how much you can borrow. The lender will not provide more funds than the home. So if you offer $400,000, but your home is valued at $380,000, the loan is based on a lower amount.
In the seller’s market, buyers may abandon unforeseen circumstances of valuation or offer valuation guarantees. If the valuation is lower than the price or guarantee, the buyer will pay the cash difference.
The evaluator assesses the value of the home based on four main factors:
Similar houses recently sold
The appraiser uses recent sales of similar homes (“Comps”) to determine the value of the property. These recently sold homes are in the same area and are similar in size, condition, age and function. By analyzing what the buyer actually paid for the equivalent property, the appraiser can create estimates that support the value of the current home in the data. The more recent and similar COMPS, the more accurate the ratings are.
The house itself
The individual features of a property play a major role in evaluation. The main factors include the home area, number of bedrooms and bathrooms, layout and overall condition. A recently renovated home, or a home with an upgraded kitchen, bathroom, or a major system (such as an HVAC or a new roof) tends to give a higher rating than a home that requires significant repairs or updates. Cleanliness and staging do not officially affect the value, but a well-maintained home can make a better impression.
Nearby markets
Appraisers take into account the current pace of the local real estate market. Does the region experience a lot of buyer activities? Do you sit at the market longer than usual? Hot markets where homes are quick and frequently exceeding the request prices can lead to higher ratings. On the other hand, in a slower market, even if your offer is strong, the evaluator may be more conservative.
Something nearby
Location is always important and the appraiser will look at nearby amenities and surroundings to assess desirability. Highly rated schools, parks, grocery stores and homes close to easy-to-go streets tend to give them a higher rating. In contrast, real estate near busy roads, industrial areas, or roads with limited access to local convenience may be valued with a lower rating.
>>Read: What is Home Evaluation: How the Process Works?
The evaluation gap clause has been explained
If the valuation is lower than the offer, these general terms determine how the transaction will proceed and how much financial risk the buyer expects.
Guarantee Clause: Buyer agrees to pay the complete difference regardless of how low the rating is. This makes it stronger in a competitive market, but increases the risk to buyers. Contingent Clause: This protects the buyer by allowing backouts or renegotiations if the appraisal is lower than the offer. It offers flexibility, but could weaken offers in a bid war. Gap coverage clause: Buyers agree to cover some of the valuation gaps up to the specified amount, increasing the competitiveness of the offer without undue risk. You and the seller must agree to the exact amount you cover, or whether you want to split the differences, and put it in writing.
What if the rating is less than the offer?
The valuation gap doesn’t have to break the transaction. Knowing what to expect and planning will help you keep things moving forward.
Prepare financially
If the valuation is low, the lender may only raise funds to the value it value and may need to cover the difference in out-of-pocket costs. This happens when the seller doesn’t agree to lower the price. In that case, you will need to pay the difference between the selling price and the valuation price in addition to the agreed down payment. Paying additional cash advances will help you act quickly and keep the transaction alive without scrambling your funds.
Unforeseen circumstances allow you to renegotiate without losing serious money. But if you waive it or include a gap clause, you will be trapped in a transaction and risk losing serious money if you leave. If you’re short on cash, consider asking your family for gift funds or using your investment. You may also have access to retirement savings without penalty. Check with a 401(k) provider or tax advisor. If you own other property, tapping Home Equity will cover the gap.
Negotiate with the seller
It’s worth trying to negotiate with the seller. Especially in a balanced or buyer-friendly market where sellers can be more flexible. If your contract has an evaluative contingency, start by asking the seller to lower the price and match the valuation. This completely eliminates the evaluation gap.
If the seller doesn’t agree with it, you can suggest splitting the difference. For example, if the gap is $10,000, you could ask the seller to lower the price by $5,000 while covering the remaining $5,000. You can also ask for other concessions, such as closure cost credit, to close the gap.
Please note: negotiating in the seller’s market can be dangerous. If the seller has a kickout clause, they can entertain another offer while giving you a short window to remove your contingency and continue. If you don’t act quickly, they can choose other buyers.
Request a reconsideration of value (RVO)
Sometimes buyers and sellers disagree with the rating. In this case, you can request a rethinking of value through your lender. This includes submitting written requests containing additional, more accurate equivalent sales, or pointing out errors in the original report.
To successfully challenge an assessment, strong evidence of the appraiser is required.
Key features or upgrades that missed mistakes made at home in reports that only performed drive-by or exterior inspections using inappropriate equivalent sales when better options are present
There is no guarantee that the value evaluated will change, but it is a valuable option. Especially when it helps agents to support cases by bringing together more powerful data.
Use the contingency of the assessment to end the assessment
If you include evaluation contingencies in your offer, you have an important safety net. If your valuation is low and you can’t reach an agreement with the seller, this clause will allow you to retreat the transaction without losing serious money.
Before you back out, talk to your attorney, especially if your contract does not include unforeseen circumstances of evaluation, as you risk losing your serious money.
Conclusion
Rating gaps occur when the home rates less than your offer and are left to cover the differences. They are especially common in competitive markets and unique homes that are difficult to compare. Good news? There are options.
Consult with the Redfin agent early in the process. They can tell you how often rating gaps occur in your area, what a typical gap looks like, and how you will build your offer with proper protection. A strong strategy in advance can save stress later.
Rating gap FAQ
How do you cover the valuation gap without cash?
If you’re short on cash, you can renegotiate the purchase price, switch to a loan with a low down payment for free up, or request a seller’s concession. In some cases, financial gifts from relatives or down payment assistance programs may be useful.
Does the valuation gap affect refinance?
yes. If you are valuing it as less than expected during your refinance, it may be difficult to qualify for borrowing, limit your ability to cash out stocks, or remove mortgage insurance.
What is the difference between valuation gap clauses and exemptions?
A valuation gap clause means that if the rating is low, the buyer agrees to cover some or all of the differences. The valuation exemption completely removes the contingency of the valuation, so buyers must continue their purchase regardless of their valuation value.
Can I challenge the low rating?
yes. A buyer or mortgage lender can submit a Value Reconsideration (RVO) if they believe the valuation is inaccurate. This includes offering new equivalent sales, pointing out errors, and modifying home features that are often overlooked, but no guaranteed approval.
