Sellers, watch out for the appraisal trap when choosing an offer…
In a competitive Southern California market when inventory is often low, buyers become accustomed to offering above the list price to increase their odds at obtaining an acceptance. So long as the home is priced realistically in accordance with the market value, there is a very good chance they can expect to receive above-asking offers. This can be thrilling, but it can also turn into a trap if they aren’t careful.
Some buyers will offer outlandishly above the asking price to secure an acceptance, knowing they have the appraisal process working in their favor. Here’s the key concept to remember: A lender will not agree to fund a loan for higher than the appraised value of the property. Say, for example, your home is listed for $850,000, you accept an above-asking offer of $925,000 and enter into escrow, then when an appraisal is conducted, the value of your home is determined to be $875,000. The lender will not fund the loan for higher than $875,000.
What happens then?
The textbook will state theoretically a negotiation can happen between buyer and seller. Perhaps the buyer would be willing to bring extra cash to the table and the seller would agree to lower the price to meet in the middle and move the deal forward. Many buyers, though, simply don’t want to pay higher than the appraised value. This puts them in the red from an equity standpoint right at the start, and the home will have to appreciate that much more to see any sort of return on the investment.
The seller, then, is faced with the decision to either agree to lower the price to the appraised value, or cancel escrow and return the buyer’s deposit.
The sneaky buyers, the ones we have to look out for, are the ones that dangle the excitement of an offer well-above asking knowing the home will never appraise at the higher price, then hoping 2 or 3 weeks into the process, the seller will simply concede rather than be faced with the annoyance of having to start all over from scratch and re-list the property seeking a new buyer.
It makes the case for why price itself shouldn’t be the sole determining factor when choosing the right offer. Perhaps there would have been an offer of $875,000, which also included a term that had the buyer paying for the seller’s closing costs, saving thousands of additional dollars, which was passed on in favor of the $925,000 offer that now needs to be canceled.
So how do you avoid falling into the trap before it’s too late?
Have your listing agent do a thorough market analysis to set the right expectations and ask them to be conservative, to set a “worst-case scenario” valuation, then be prepared for this to be the appraised value. If the appraisal comes in higher, it’s a fantastic gift you will enjoy. But if you do select that $925,000 offer, be prepared in advance for the appraisal to come in lower. Perhaps choosing an offer that came in at $875,000, which had the buyer paying seller closing costs, and a 30-day escrow period would ultimately have been a wiser choice than the $925,000 offer with 20% down, a 45-day escrow period, has the seller paying their own closing costs, and then needed to be cancelled anyway when the appraisal came back.
As you can see, there’s a deeper level of analysis that goes into choosing the right offer, the smart offer, the one that can ultimately lead to a smooth and stress-free escrow process, with a happy close that meets your expectations and goals. So above all else, make sure you choose a real estate agent who is capable of being analytical, who can read between the lines, go beyond the surface, and therefore make an informed suggestion on the right course of action.