If you’re interested in purchasing a new home in New Jersey in 2023, you may have discussed the topic of “appraisal waiver,” “waiving the appraisal,” or “covering the appraisal gap” with your realtor. These phrases are all shorthand for the same topic: When you agree to buy the property despite a low appraised value.
The purpose of this article is to discuss whether you should buy a property despite a low appraisal, and if you CAN buy a property if it appraises low.
Selecting a new home is a very personal decision, and the rationale for selecting one property vs another may be based on financial or non-financial factors.
The non-financial factors such as location, proximity to shopping, proximity to school, quality of the school system, ethnic and/or religious makeup of the community, are all topics that should be considered regardless of the appraised value of a property.
The financial factors to consider and discuss with a mortgage loan officer NJ include:
1. Will I be able to sell my property for the original purchase price or a higher price in the future?
2. How long will I have to hold onto my property before I can sell the property and make a profit (after factoring in realtor commission, transfer taxes, legal expenses, and other costs)?
3. How much extra will I have to pay (if I pay more than the appraised value for my property)? Does the extra amount depend on the amount of my residential mortgage NJ and/or my down payment percentage?
4. Will I have a higher monthly mortgage payment if my property appraisal is low?
For question 1, the answer is, “It depends how long you wait to sell your property, and on how quickly properties are appreciating in the area that you are purchasing.” Many areas of New Jersey are appreciating at 10% or greater rate each year. The home appraisal process is always BACKWARD-looking and uses comparables (similar properties) that have sold in the most recent 12 months to justify the appraiser’s opinion of value. If home prices are rapidly increasing, it is very likely that the market value (what someone is willing to pay for a property) will EXCEED the appraiser’s opinion of value, because the appraiser is looking at comparables that sold in the past for 5% - 10% less than the current market value.
Let’s consider an example where the purchase price is $590,000 and the appraisal comes in at $550,000. Should the buyer cover this appraisal shortfall? If the property is in an area that appreciates 4% per year and the buyer plans to hold the property for at least 3 years before they sell, then the estimated sale price of the property in 3 years will be $618,675!
After 1 Year = $550,000 + ($550,000 x 0.04) = $572,000
After 2 Years = $572,000 + ($572,000 x 0.04) = $594,880
After 3 Years = $594,880 + ($594,880 x 0.04) = $618,675
So, the buyer will be able to sell the property for more than the original purchase price, but will they be able to make a profit after paying all closing costs to sell their property?
This topic is the answer for question #2 from above: How long do I have to hold onto my property to make a profit, after paying for all the expenses associated with selling?
Using the example above, let’s assume that after 3 years, the buyer sells their property for $618,000. They will pay the following estimated fees:
1. Realtor Commission – 5% = $618,000 x 0.05 = $30,900
2. Transfer Taxes (Sales Tax) = $5,376 (online calculator here)
3. Attorney Fee = $1,750 (this is just an estimated average price)
4. Miscellaneous Costs (repair credits, prorations for utilities, taxes, HOA fees, etc) = $4,000
In total, the selling costs would be:
Total = $30,900 + $5,376 + $1,750 + $4,000 = $42,026
So, in our example of buying for $590,000, receiving a low appraisal of $550,000, and selling 3 years later for $618,000, the amount that the buyer would LOSE is:
$618,000 - $42,026 - $590,000 = (- $14,026)
So how long would the buyer have to hold their property before selling it to make buying at $590,000 a decision that would not cost them money when they sell?
The answer is approximately 3 years and 7 months, and this would yield the buyer a profit of about $169.
Now for question #3 – how much extra do I have to pay at closing if I want to waive the appraisal contingency and purchase a property despite a low appraisal?
Let’s assume in our example that the buyer was planning to make a 10% down payment on a $590,000 purchase price, and the appraisal came in at $550,000. If the buyer wanted to MAINTAIN their down payment at 10%, then the buyer would need to cover the appraisal shortage in cash ($40,000), and their down payment would be reduced from $590,000 x 10% = $59,000 TO $550,000 x 10% = $55,000. So overall, the buyer would pay $40,000 extra in appraisal shortage and $4,000 less ($59,000 - $55,000) in down payment. So, the buyer’s total cash to close would INCREASE by $40,000 - $4,000 = $36,000. Another way to think about this is that because the buyer is putting 10% down payment, they need to pay 100% - 10% = 90% of the appraisal shortage amount. The appraisal shortage amount is $40,000, so the buyer must pay $40,000 x 90% = $36,000.
What if the buyer had a different down payment percentage – 15% for example – would this affect how much the buyer had to spend in extra funds to cover the low appraisal?
YES! The amount they would need to pay would be (100% - 15%) x ($40,000) = $34,000. So, the down payment percentage DOES affect the amount of extra cash needed at closing to cover a low appraisal, IF the buyer wants to keep the same down payment percentage that they originally planned on making.
What if the buyer does not have an extra $36,000 to cover the gap associated with a low appraisal? Can they still purchase the property?
This question brings us to Question #4 from above – Will I have a higher mortgage payment if I have a low appraisal?
Another alternative to covering a low appraisal with extra cash at closing is to reduce the buyer’s down payment percentage. For example, let’s assume that this buyer purchased a home for $590,000, received an appraisal of $550,000, originally planned on 10% down payment, and has now decided to pursue 5% down payment.
The down payment is based on the lower of the purchase price or appraised value, so the calculation is:
$550,000 x 5% = $27,500
The new amount needed for appraisal shortage ($40,000) and down payment ($27,500) is:
$40,000 + $27,500 = $67,500
Compared to the original amount that we were planning to use for down payment (10% of $590,000 = $59,000), the new amount is only $67,500 - $59,000 = $8,500 more than originally planned.
There are some other considerations when reducing your down payment that you should review with an experienced home loan officer in New Jersey, including:
1. Do I qualify for a loan with a higher monthly payment?
2. Do I have to pay off any monthly debts to qualify for a higher monthly payment?
3. Does my interest rate increase?
4. Do I have to pay any additional loan fees to my mortgage broker near me, such as points, to keep the same interest rate?
5. Does my PMI payment increase?
6. Will the length of time that I’m required to pay PMI increase?
7. The loan amount borrowed is larger, so I will always have to pay more in principal and interest payments (even if my rate stays the same).
After reading this article, it’s clear that there are many considerations when deciding whether to make an offer that includes an “appraisal waiver” or “covering an appraisal gap.”
We recommend speaking with one of the best mortgage brokers in NJ before making any decision about the terms of your purchase contract offer.