You have a signed purchase and sale contract, the home inspection is complete, and the buyer is moving forward with financing. Then the appraisal comes back lower than the agreed purchase price.

What happens next?

A low appraisal does not necessarily mean that a Vermont real estate transaction will fall apart. In many transactions, the buyer and seller are able to negotiate a solution and proceed to closing. However, a low appraisal can affect the buyer's financing and may trigger important provisions and deadlines in the purchase and sale contract.

Both buyers and sellers should understand their options before deciding how to proceed.

What Does a Low Appraisal Mean?

When a buyer finances the purchase of a home, the lender will usually require an appraisal. The appraiser provides a professional opinion of the property's market value, which the lender uses in determining how much it is willing to lend.

The appraisal is primarily for the lender's benefit. The lender wants to make sure the property securing its loan has sufficient value.

An appraisal is different from a home inspection. A home inspector evaluates the physical condition of the property and identifies defects and potential problems. An appraiser's primary purpose is to develop an opinion of the property's value.

A problem can arise when the appraised value is lower than the price the buyer and seller agreed upon in the purchase and sale contract.

Why Does a Low Appraisal Affect the Buyer's Mortgage?

Mortgage lenders generally calculate the amount they are willing to lend based upon the lesser of the purchase price or appraised value.

Consider a simple example.

Suppose a buyer agrees to purchase a Vermont home for $400,000 and expects to obtain a mortgage equal to 80% of the purchase price. If the property appraises for $400,000 or more, an 80% loan would be $320,000.

But suppose the appraisal comes back at only $375,000.

The lender may calculate the 80% loan based on the $375,000 appraised value instead. An 80% loan based on that value would be $300,000.

That creates a $20,000 difference in the anticipated financing. Unless the parties change the transaction or the financing changes, the buyer may need to contribute additional cash to complete the purchase.

The exact effect of an appraisal on a particular loan depends upon the loan program and lender requirements, so the buyer should promptly discuss a low appraisal with the loan officer.

What Are the Options When a Vermont Home Appraises Low?

A low appraisal does not automatically end the transaction. There are several possible outcomes.

In our experience handling Vermont real estate transactions, the most common solution is for the buyer and seller to negotiate a lower purchase price.

The parties might agree to reduce the price all the way to the appraised value, or they might negotiate another amount. The buyer may also decide to contribute additional cash toward the purchase.

There can be other ways to restructure the transaction.

For example, if the seller previously agreed to pay some of the buyer's closing costs, the parties might agree to reduce that seller contribution while also reducing the purchase price. Reducing the seller-paid closing costs may allow the seller to lower the purchase price while receiving approximately the same net proceeds from the sale.

There is no single solution that works for every transaction. The buyer's available cash, financing terms, contract provisions, seller's financial objectives and the size of the appraisal difference can all affect the negotiations.

Does the Seller Have to Lower the Price After a Low Appraisal?

Generally, no.

A low appraisal does not by itself require a Vermont home seller to reduce the agreed purchase price. The seller can refuse to change the price and leave the buyer to decide whether to proceed under the terms of the contract or exercise any applicable contractual right to terminate.

However, refusing to negotiate carries practical considerations for the seller.

If the current transaction terminates, the seller may have to put the property back on the market and wait for another buyer. During that time, the seller may continue paying mortgage interest, property taxes, insurance, utilities and other carrying costs.

There is also no guarantee that the next buyer will make an equally attractive offer.

Perhaps even more importantly, changing buyers does not necessarily solve the appraisal problem. A second buyer's appraiser may reach a similar conclusion about the property's value.

A seller deciding whether to accept a price reduction should therefore consider more than the difference between the contract price and appraised value. The seller should also consider the time and expense of returning to the market, the likelihood of obtaining another acceptable offer, and the possibility that another appraisal will present the same issue.

Can a Buyer Terminate the Contract Because of a Low Appraisal?

Sometimes, but not always.

The answer depends on the terms of the particular Vermont purchase and sale contract.

Many Vermont real estate contracts contain an appraisal contingency, but not all of them do. An appraisal contingency may give the buyer certain rights if the property does not appraise at the required value.

The precise language of the contingency matters.

A buyer should never assume that receiving a low appraisal automatically creates a right to terminate the contract.

The Financing Contingency May Also Be Important

Even when there is no applicable appraisal contingency, a financing contingency may become important.

Because lenders generally base their lending decisions on the lesser of the purchase price or appraised value, a low appraisal can affect the buyer's ability to obtain the financing required by the contract.

If the lender denies the buyer's loan because of the low appraisal, the buyer may be able to terminate under an applicable financing contingency and recover the deposit, assuming all of the requirements and deadlines of that contingency have been satisfied.

On the other hand, the lender may still be willing to make the loan, but for a smaller amount.

The buyer might then have the option of contributing additional cash to make up the financing difference and proceeding with the purchase.

Whether the buyer is required to do so is a legal question that depends upon the particular contract and circumstances. This is one reason a buyer who receives a low appraisal should speak promptly with both the buyer's loan officer and Vermont real estate attorney.

Do Not Miss the Contingency Deadlines

A low appraisal can create a time-sensitive problem.

Appraisal and financing contingencies generally contain deadlines. Those deadlines should be taken seriously.

If a buyer does not exercise contractual rights within the required time, the buyer can lose the protection of the contingency. Depending upon the contract and circumstances, a buyer who later fails to close could potentially put the buyer's deposit at risk.

Buyers should therefore avoid waiting until shortly before closing to address a low appraisal.

As soon as an appraisal problem becomes known, the buyer should review the situation with the loan officer and real estate attorney so that the applicable contract provisions and deadlines can be identified.

Can You Challenge a Low Appraisal?

Sometimes.

An appraisal is a professional opinion of value. It is not an exact scientific measurement, and reasonable appraisers can reach different conclusions about the same property.

If the buyer, seller, real estate agent or another person involved in the transaction identifies relevant comparable sales that were not considered by the appraiser, those sales may sometimes be brought to the appraiser's attention through the lender. The lender may have a procedure for requesting a reconsideration of value.

The appraiser is not required to change the opinion of value simply because additional comparable properties are identified. However, particularly relevant sales that were overlooked may provide a legitimate basis for reconsideration.

In some circumstances, it may also be possible to obtain a second appraisal. Whether a lender will order or consider another appraisal depends upon the lender and applicable loan requirements.

A second appraisal could reach a different value, but there is no guarantee that it will.

Why Vermont Properties Can Be Particularly Difficult to Appraise

Appraisals can be especially challenging in parts of Vermont.

An appraiser typically looks at recent sales of comparable properties when developing an opinion of market value. In a neighborhood containing many similar homes and frequent sales, there may be several good comparable properties available.

That is not always the case in Vermont.

Rural Vermont properties can be unique, and there may be relatively few recent sales nearby. A home may differ substantially from other properties in acreage, age, construction, condition, outbuildings, location, views or other characteristics.

When there are few truly comparable recent sales, an appraiser may need to consider properties located farther away, sales that occurred further in the past, or properties that differ significantly from the home being appraised. The appraiser then makes adjustments to account for those differences.

The more judgment required in selecting and adjusting comparable properties, the more subjective the valuation can become.

As a result, an appraisal of a rural Vermont property can sometimes be substantially different from what the buyer, seller or real estate agents expected. It is also possible for two qualified appraisers reviewing the same property to reach different opinions of value.

A low appraisal therefore does not necessarily establish that the buyer agreed to pay "too much" for the property. It represents one appraiser's professional opinion of market value based upon the information and comparable sales available.

What Happens After the Buyer and Seller Reach an Agreement?

If the parties negotiate a solution, the new terms should be put in writing.

For example, if the parties agree to reduce the purchase price or change the amount of seller-paid closing costs, a written addendum to the purchase and sale contract should document those changes.

In Vermont transactions handled by Peet Law Group, these addenda may be prepared by our office or by the real estate agents involved in the transaction.

The lender and closing attorney also need to know about changes to the financial terms so the loan and closing documents can accurately reflect the final agreement.

What About a Cash Buyer?

A low appraisal can affect a cash transaction differently because there is no mortgage lender limiting the amount it will finance.

A cash buyer who wants the property could simply proceed with the purchase despite an appraisal below the purchase price.

However, the contractual issues can be particularly important for a cash buyer.

A financed buyer may potentially have both an appraisal contingency and a financing contingency to consider. A cash buyer generally cannot rely upon a financing contingency to terminate because there is no financing.

That makes the terms of any appraisal contingency especially important to a cash buyer who wants the ability to terminate or renegotiate if the property appraises below the agreed purchase price.

What Should a Vermont Buyer Do After Receiving a Low Appraisal?

A buyer should first determine exactly what the appraisal means for the proposed financing. The loan officer can explain whether the lender will still approve the loan, whether the loan amount will change, and whether a reconsideration of value or another appraisal is possible.

The buyer should also promptly discuss the purchase and sale contract with the buyer's Vermont real estate attorney.

The attorney can review the appraisal contingency, financing contingency, deadlines, notice requirements and other relevant provisions and help the buyer understand the available options.

Those options might include negotiating a lower price, modifying seller-paid closing costs, contributing additional cash, seeking reconsideration of the appraisal, obtaining another appraisal if permitted, proceeding at the existing price, or terminating the contract if the contract permits it.

What Should a Vermont Seller Do After a Low Appraisal?

A seller should evaluate both the legal and financial consequences before responding to a request for a price reduction.

The seller generally does not have to accept a lower price simply because the appraisal came in low. But insisting upon the original price can mean losing the current buyer if the buyer has a contractual right to terminate.

The seller should consider how much of a reduction is being requested, the carrying costs associated with keeping the property longer, current market conditions, the likelihood of another acceptable offer and whether another buyer could encounter the same appraisal problem.

Sometimes accepting a reasonable reduction and proceeding to closing produces a better financial result than starting over with another buyer.

Peet Law Group represents home buyers and sellers throughout Vermont and regularly assists clients with purchase and sale contracts, financing and appraisal issues, title matters and real estate closings. We have offices in Williston and White River Junction and provide real estate legal services throughout the State of Vermont.