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I spent my weekend with some awesome buyers looking for a home in Denver, CO. They were ideal clients, as they had great finances, knew what they wanted, and were excited and ready to act. That said, Denver’s market is cuh-razy competitive right now, so to help make their offer the best it could be, we offered $5,000 in appraisal gap coverage (and they got it!).

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When Would You Need Appraisal Gap Coverage?

In a competitive housing market like Denver’s, people can get really crazy with their offers. You see a lot of money flying around without the comps to back it up. This is a problem for a seller because they might take the best offer, only to have the house appraise for far less. If that happens, the buyer and the seller have to agree on what the price is going to be and/or who will pay for the difference between the offer price and the appraisal. So, appraisal gap coverage helps the seller feel better about taking a high offer even if they are worried the appraisal won’t support it.

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How Does This Work With an Offer?

Appraisal gap coverage makes your offer stronger in any market. That said, they are almost always used in a seller’s market, where the buyer needs to incentivize the seller to take their offer.

So, let’s say you are in the same situation as my clients this weekend: considering a hot 2-bedroom condo in downtown Denver listed for $385,000 with offers pouring in from all sides. You know you need to come in strong with a serious offer. Like them, you might put in an offer for $415,000 with appraisal gap coverage of $5000.

Hypothetically, let’s say the place appraises at $400,000.

An offer for $415,000 (without appraisal gap coverage) would mean that the lender would only secure the loan for $400,000. There is now a $15,000 difference between what the seller thought they could get and what the loan is. Now everyone is required to re-negotiate: Will they split the $15,000? Will they lose the contract? No one wants this because buying/selling a house requires a lot of paperwork, so sellers really don't want to be in this position.

An offer for $415,000 on a house that appraises for $400,000 with $5,000 in appraisal gap coverage means that the buyer is securing appraisal + $5000.00. So, in this case, if they offered $415,000 and it came back at $400,000, they are guaranteeing they will pay at least $405,000. The offer is stronger because the seller knows they will get appraisal + $5000, even if the market doesn’t support this price.

What Else Should I Know About Appraisal Gap Coverage?

First things first, your loan will not support this, so make sure you have the cash to cover it. If you have a $5000 appraisal gap and the appraiser says it's worth less, plan on coming to the closing table with an extra $5000 in cash.

This is a great tool to help your offer stand out in a competitive market.

Have you used appraisal gap coverage before? What other strategies do you bring out in a hot market?

Comment below!

Catherine Coy from Huntington Beach, California

Replied over 1 year ago

You’re talking about waiving the appraisal contingency in the offer. That’s not new or inventive. What’s so great about over-paying for a property? The new homeowner is under water the minute the deed records.

Adam Cranmer Rental Property Investor from Winter Haven, FL

Catherine, your comment is clearly not directed at a seller’s market, particularly as strong as the one that Erin writes about (Denver and CO Springs) that is growing at 10%+ per annum. The simple fact that a 1.25% appraisal deficit ($5,000) is considered to be putting the homeowner “under water the minute the deed records” is extremely short-sighted. It is certainly not new or inventive, but it does work. Due to all-cash offers, every little bit helps. I laughed my way to the bank using this technique as I put in an appraisal contingency AND wrote a letter to the homeowners…on a house that I purchased for $330k and sold 3 years later for $505k. I’ll take my $175k (minus about $30k in reno) and thank people like Erin for her ingenuity and determination in a tough market. (Full disclosure, I have never worked with Erin, but respect her thoughts).

Erin Spradlin Real Estate Agent from Denver, CO

This article wasn’t intended to be an article about buying a home with instant equity, as much as it was strategies for making offers more appealing- and appraisal gap coverage is one of the ways to do that. By limiting the coverage by $5,000, you limit the risk your client takes while also putting in a strong offer. Additionally, in strong markets where properties are flying fast, it’s reasonable to assume that $5k gap might be realized soon (especially as we enter summertime.)

Ray Slack Investor from Bowie, Maryland

Not a bad idea. As a seller that flips 10-15 hours a year, I would definitely see this as a huge plus for me to accept that buyer’s offer over a similar offer without it. My only criticism is that calling it “appraisal gap coverage” sounds like it’s insurance that you can buy to cover the gap in the value.

Yeah, because as the seller in these kind of markets, you are receiving a lot of offers (some of them pretty incredible) and you have to decide if the highest one really is the best and what factors come into play (cash v. loan, the appraisal, rent backs in some scenarios, etc.) So having something that at least makes the offer seem genuine seems like a better starting place to me.

Jordan Thibodeau Rental Property Investor from San Jose, CA

Thanks for the excellent post Erin!

Thanks! That’s really nice to hear!

Dean Lemont Investor from Los Angeles, California

Interesting (long term) buyer strategy. I agree that “gap coverage” sounded like some kind of insurance at first. Of course, in your example, there’s still the matter of the $10k difference to be negotiated. But I suppose it’s better for the buyer in a hot market to be in the position to even participate in that negotiation by inserting this sort of clause to the contract, rather than to NOT get into escrow at all – assuming the buyers are willing to be under water for a time and have extra cash to bring to the table for their dream home. In Los Angeles for example, paying $5,000 over appraisal will almost certainly be overcome relatively quickly, but buyers need to understand they’re “overpaying” by that amount – depends on how much they love the home! If they’re staying there for the long haul, there’s not a lot of risk in paying .5% over appraised value. Many appraisals would vary that much in and of themselves. And they could always walk away. Thanks, Erin!

Exactly. If they aren’t looking to move any time soon, the risk is pretty minimal. I think it definitely factored into them getting the home as well.

Gary

I used your method in Las Vegas on my house which I bought as a probate sale. I usually use a buying agent and he suggested your method. I used $7k instead of $5k, but it worked! Las Vegas runs at extremes, either really hot, or as it is now, nearly dead. At the time of purchasing, I had already been out maneuvered on 50+ offers that I had made. When this one was accepted, my offer was full price plus the “appraisal insurance” (as we called it) and we were both shocked that the offer was accepted without any counter offer. The final gem in the crown, the property appraised for $2k over on a VA loan. Jackpot!!! Even though this wasn’t an investment property, apparently most sellers are able to see the advantage to this method. I now always offer the appraisal insurance with my initial offer. It can also be used as a bargaining chip in any counter offers. The only downside is if the property does fall short in the appraisal. As long as the numbers worked in the first place, that shouldn’t be much of a problem.

Congrats on getting into a home with this method. A lot of people just do $1K, but I don’t think that’s a big enough gap to incentivize the seller if there are other factors in play, which is why we moved up to $5k.

Ryan Wittig Real Estate Investor from Boston, Massachusetts

LOL. A “hot 2 BR” in any of the desirable parts of Boston would cost $800K- 1 Million + these days (assuming it’s bigger and 1,000 sq. ft.). This is a somewhat interesting tactic, but I’m not really sure how successful it would be against all cash offers which we see in 60-70% of our deals… We are waiving financing and inspection contingencies to combat cash, but we are still losing 9 of 10 times. Such is the market today. I think this would be most effective in properties most likely to be bought by an owner occupants rather than investors who are either bringing all cash (or hard money disguised as cash) or willing to scrap the financing contingency all together… It’s another arrow in the quiver or creativity though. Thank you for sharing

My fear (for my buyers) is that we’re headed in the same direction. I feel like this is one of a few tools that remains helpful in this market- but we are also being flooded every day by all cash investors.

Juli Franklin

I really appreciated this article, Erin. I’ve been employing this approach on both the buyer and seller side in my market (most definitely a seller’s marker, south of Boston) but I never had a name for it! I like the name “appraisal gap coverage”. My husband and I tried using this to buy a couple of investment properties but lost out to cash offers, as Ryan spoke of above. But on the seller side, I was able to get my seller’s $20,000 over appraisal on their condo ($310,000 listing price, $310,000 appraisal, $330,000 purchase price) by asking the buyer’s agent to have his client provide $20,000 in appraisal gap coverage because we knew the appraisal wouldn’t come back high enough to support his $330,000 offer. He paid $20,000 over appraisal by putting in extra cash but he was happy to and my sellers were thrilled. We’ve also had success with our buyer clients using escalation clauses of at least $1,000, sometimes $2,000 over the highest competing offer. Thanks for sharing your experience with this!

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