Question: I just entered into a contract to sell my house, and am pleasantly surprised at the bidding war which resulted in a very high contract price. However, my real estate broker has warned me that since few houses have sold recently in my neighborhood, the appraisal may come in lower than the purchase price. What happens in such a case? If the appraisal is low, is there anything I can do about it?

Answer: This has become a serious problem in the past year, as house prices have skyrocketed out of sight in many areas around the country. If your buyer gets an appraisal which is lower than the sales contract, you -- and your buyer -- have a number of options.

Let's look at your first question: what are the consequences of an appraisal which comes in at a value lower than the contract price?

Assume for this discussion the following: sales price is $300,000, the purchaser will obtain an 80 percent loan ($240,000), and will give cash for the difference between the loan amount and the sales price ($60,000). If the house appraises at $300,000 or more, the lender will be able to make an 80 percent loan.

However, if the house only appraises at $280,000, the lender will only want to make a loan in the amount of $224,000 (i.e. 80 percent of the appraised value). In order to buy the house for the full contract price, the buyer will have to come up with another $16,000 ($240,000 - 224,000).

Everything involving real estate is negotiable, and the first place to look is the sales contract. Is there a financing contingency in the contract? If there is no such contingency -- and if there are no other contract clauses dealing with the appraised value of the house -- your buyer will have no legal alternatives; he will have to purchase the house (thereby being required to come up with all the extra cash) or he will be in default of the contract and will most likely be required to forfeit the earnest money deposit which was given at the time the contract was entered into.

In my area, most real estate brokers use a standard form contract, called the Regional Sales Contract. Paragraph 9 of that Contract contains the financing contingencies, and they should be read carefully (before the contract is signed) by both buyers and seller. In general terms, this paragraph states that the buyer has X number of days in which to get a loan approval letter, and if that approval is not forthcoming within the time limits, the purchaser can terminate the contract and get the earnest money deposit returned.

The contract goes on to state that the financing contingency continues even after the time limits spelled out in the paragraph unless the seller gives the buyer three days notice that the contract will be declared null and void. During these three days, the buyer can keep the contract alive (if this is his desire) by either (l) getting a loan commitment letter from a lender or (2) removing the financing contingency and demonstrating to the seller that the buyer has sufficient funds available to complete the Settlement.

This is very confusing -- but very important -- contract language, and should not be ignored when the contact is being written.

Some buyers, concerned that the house may not appraise at the contract price, are adding additional finance clauses when they submit their offer to the seller. For example, one buyer added language to the effect that: "if the house does not appraise at the contract price, purchaser has the option to cancel the contract or purchase at the appraised price."

This language is fine for the buyer, but not acceptable to the seller. What if the house appraises extremely low? Does this language bind the seller to sell at the low price? In my opinion, it probably does. Thus, the seller should add the following sentence to that language: "If seller does not agree to sell at the appraised price, this contract may be declared null and void at the option of the purchaser."

Because contract language varies around the country and from form to form, it is very important to review such language with care and appropriate assistance from a broker, attorney, or both.

Now, let's look at your second question: what rights do you have if the appraisal comes in lower than the contract price?

First, ask yourself if your house is really worth the contract price. Did your buyer just get carried away in this real estate market frenzy, and will he be calmed down when the appraisal comes in?

You have the right to obtain a copy of the appraisal, and should review it carefully. Are there clear errors in the report, such as using the wrong dimensions of the lot, ignoring the many additions and upgrades you have made over the years, or calling the house a wood frame instead of brick? Demand that the appraiser come back to the property, and reevaluate the situation based on the errors that you have noticed.

Keep in mind, however, that appraising property is not a science; at best, it is an attempt to determine what a piece of property is worth, based on a number of different methods of evaluation. Generally speaking, residential properties are assessed using what is referred to as the "Sales Comparison Approach". Using this procedure, the assessor compares your house with sales of similar properties. While appraisers use such benchmarks as square footage, replacement value and other similar concepts, the bottom line in my opinion is that appraising a house is a very subjective exercise.

As you can understand, since no two houses are really similar, there has to be a lot of subjectivity involved in any assessment. However, before the appraiser can make comparisons, he/she must be accurate in evaluating the condition of your property. If the appraiser made mistakes, these mistakes may be the cause of the lower appraisal, and the appraiser must go back to the property and correct the mistakes.

I am also a believer in going to the top, when necessary. Thus, if the appraisal comes in too low, I would try to meet with the president of your buyer's mortgage company, or at least someone in a supervisory position above the loan officer, to discuss your situation. It may very well be that the lender will put pressure on the appraiser to reassess your house. I have heard of numerous instances where appraisers have made mistakes, but have been honest enough to go back to the house with a view toward correcting the original appraisal.

The best test of market value still is what a ready, willing and able buyer will pay a ready, willing and able seller. The price sets the market value. All of the other factors are significant, but not necessarily critical to a determination of price.

You should also discuss the situation directly with your potential buyer. Try to avoid having to go through the real estate brokers, if possible. Ask the buyer, point blank, "do you really want to buy our house or not?"

If the buyer is truly interested in buying, there are a number of ways to accomplish this. Whether or not the appraiser modifies and increases the appraisal, you can compromise on the price, and you can agree to take back some of the financing to make up the difference between what the lender is willing to lend and what the purchaser originally wanted to borrow.

But if you determine that your buyer really wants out of the deal unless you reduce the price, that will be a decision which only you can make. If the house appraised lower than the contract price, perhaps it was not worth that higher price and you may decide to sell it anyway.

For more articles by Benny Kass, please press here.

Published: May 21, 2001

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