Simply put: its when a buyer offers to buy a home for X, but the bank appraises it lower than the offer price. The difference is known as the appraisal gap. To understand appraisal gaps first we need to take a short time travel trip back to the 2008 market crash.
Back then the banking industry was engaging in some fairly sketchy lending practices, including things like no-doc loans (also called "liar's loans") which required little to no verification of the borrower's stated income. Home prices were skyrocketing due to the availability of loans to just about anyone who wanted them, which massively increased the pool of buyers.
The low interest rates we saw in fall 2021 have caused a similar situation in todays market: loans are cheap so more people get loans, more buyers flood the market, increased buyer activity means increased competition, which means increased sale prices. But hold up a second... what makes things so different this time around?
You see, back in 2008 the banks weren't doing such a great job making sure appraisals were accurate. So a buyer gets approved for a loan they can't afford, then goes and makes an above-asking-price offer on a home which is already inflated above market value, the bank says "$400,000 for a dilapidated 800 square foot, 2 bed, 1 bath house in Tampa on a lot the size of a postage stamp? Seems fair enough!" The buyer and seller sign some paperwork, the loan is signed, sealed, delivered and everyone goes on their merry way.
There's a problem though. Our borrower was approved for a loan they couldn't afford, and subsequently couldn't pay their loan. After a few months of late and missed payments the bank decides to move forward with foreclosure. Under normal market conditions this wouldn't make the news, except it wasn't just one borrower. It was thousands. Suddenly the banks found themselves foreclosing on thousands of homes. And when those homes entered the marketplace it was saturated with inventory, causing prices to drop back to normal market levels. And now the bank is stuck with a $400,000 home that could only be sold for $300,000.
So what does the market crash in 2008 have to do with appraisal gaps? As you're aware, we seem to be in another bubble with the real estate market. Home prices have skyrocketed a whopping 22 percent as of May 2022; and once again the bidding wars have led to many homes selling for over asking price, buyers waiving inspections, and have dropped the median days on market just 6 days in Hillsborough County, Florida.
The key difference in these sales? The appraisal gap. Now, when our borrower offers $400,000 for their dream home the bank is more diligent in appraising the property for the true market value. So when the appraisal comes back for $300,000 the buyer has two choices: back out of the contract or pay the difference out of pocket at closing in addition to their down payment and other closing costs.
The bank in this situation has essentially said "you can buy the house for whatever amount you want, but we are only lending you money equal to the market value". This results in a far less risky loan for the bank in part because it ensures the mortgage payments are smaller (which means default is less likely), and in part because if the bank should have to foreclose they aren't $100,000 in the hole.
There's no doubt that the housing market was turned upside down during the pandemic: virtual showings, online home-buying, the rise of iBuyers, record-low interest rates, then record increases in interest rates, the Great Resignation, and the exodus of office workers to the suburbs as remote work becomes increasingly popular and feasible. But there are some key differences between the conditions in 2008 and 2022 real estate market. If you have questions about selling your home or how to buy a home in a seller's market don't hesitate to reach out to us and speak with one of our qualified agents!