Whatever you do, don’t buy a condo in Oakland in 2023!
I say that because some of our refi appraisals are coming in surprisingly low – but fortunately, we have options.
We are also seeing a lot of purchase appraisals come in under contract price, so I wanted to again set out all of the options when appraisals come in low.
I am updating a blog from last year but focusing heavily on the PMI option (#6 below), as PMI is extremely cheap right now and “lump sum” PMI often proves to be a more effective option than most people realize.
6 Options When Appraisals Come in Low
Below are six options available when an appraisal comes in under contract price, or under the amount necessary for a refinance.
1. Rebut the appraisal.
This approach can be surprisingly effective, as long as there is adequate data to support the rebuttal. The data must also comply with appraisal guidelines, as per this blog: Comparable Sales Appraisers Can and Can’t Use. Note too that some large Appraisal Management Companies (AMC) tend to dig in their heels no matter what when it comes to rebuttals. Therefore, lenders also need a cooperative AMC or an internal appraisal panel, like we have at JVM, for a rebuttal to be effective. VA appraisals are also difficult to rebut because lenders have to use “VA-approved” appraisers, who also tend to be a bit more obstinate when it comes to rebuttals.
2. Bring in the extra cash necessary to make up the appraisal shortfall.
Lenders will only lend against the lower of the appraised value or the contract price. If an appraisal comes in $25,000 under contract, buyers must bring in that $25,000 over and above their original down payment. If a buyer lacks sufficient cash to cover the shortfall, then we need to focus on one of the other four options.
3. Change financing to a lower down payment option to free up cash to make up the shortfall.
For example, a buyer planning to put down 20% on a $500,000 purchase could instead put down 10% if the appraisal comes in $50,000 lower at $450,000. This buyer could then get 80/10/10 financing – and be “out of pocket” about the same amount he would have been out originally if the appraisal had come in at contract price. Buyers can also switch to FHA financing and only come in with a 3.5% down payment. We have performed these “financing switches” many times to salvage transactions when appraisals come in low.
4. Negotiate a price reduction with the seller.
This option is often not viable in a competitive market, as most agents know – especially when sellers have ample backup offers. That said, we have seen some realtors work wonders with price reductions by appealing to the seller’s desire to sell quickly and easily. Usually, by the time the appraisal is in, we have full loan approval and can sweeten a price reduction with the removal of all contingencies.
In slower markets, our Appraisal Manager is more than happy to provide comparable sales data to support a lower purchase price.
5. Order a new appraisal.
This can only be done if we can prove there are severe “quality issues” with the appraisal, e.g. the appraiser made significant mistakes with measurements, room counts, location factors, data analysis, etc. We cannot just order a new appraisal because we don’t like the result or the value conclusion; we have to prove and document the “quality issues” or we risk running afoul of both regulators and the investors that buy our loans.
6. Use PMI to salvage a transaction – monthly or lump sum
Private Mortgage Insurance, or PMI, is insurance that is required when loan-to-value (LTV) ratios are over 80%. Both buyers and sellers can pay for it. We love PMI now because it is so inexpensive (due to competition) and because it is so much easier to eliminate. I discuss all this here: Why We Love PMI! It is an excellent option when sellers refuse to budge on price.
Monthly PMI is exceptionally cheap for strong borrowers, as it can be as low as 15 basis points for LTVs under 85% – meaning that a borrower only has to pay 15 basis points (0.15%) against the loan amount for the entire year (but in 12 monthly installments). Refinancing borrowers with low appraisals should not despair, as PMI rates this low can easily save both purchases and refinances.
Lump sum PMI is a single payment that borrowers can pay upfront (at close of escrow) to cover all PMI costs and thus avoid monthly PMI payments. There are numerous advantages associated with lump sum PMI, but two of them are: (1) it is surprisingly inexpensive; and (2) the entire cost can be added on to the mortgage or “financed.” In this blog – Low Appraisal? Use Financed Lump Sum PMI To Save Deal! – I explain how this works in much more detail. In that blog, I share an example of how an appraisal came in $35,000 below the contract price of $670,000 – and how the borrowers intended to put down 20% but only had enough for 15% down after covering the appraisal shortfall. So, they opted for lump sum PMI at a cost of only $2,400, and that only increased their housing payment by $16 per month.
