Happy Home Bidding
You found the home of your dreams. After several bidding wars you finally win the house with an incredible offer well above the asking price. If you are lucky enough to have won the RSU lottery, you can pay cash and not worry about a loan. However, if you are like the rest of us, the next step is securing the loan which means your bank will need an appraisal.
What is an appraisal?
An appraisal is an independent report that provides the bank an estimated value on the home based on a market assessment. Usually sold homes are used as comparables (comps) that are of similar type (SFH, condo, townhouse, multi-family) and of similar size both for living which includes bedrooms and bathrooms and lot square footage. The comps also need to have been recently closed such as within a 1 to 3 month time from the time of the appraisal report.
Bay Area real estate market has been on fire in 2021 and 2022. Winning bid prices have continued to break records at unprecedented levels. The housing experts proclaim that inventory is the issue, however there are plenty of homes all over the Bay Area. The real problem is that everybody wants to buy in the peninsula area of the Bay Area. Cities such as San Mateo, Belmont, San Carlos, Palo Alto, Los Altos, and Cupertino regularly have sales upwards of $3M to $4M. This is mostly due to top notch schools, larger lot sizes, and proximity to office locations such as Facebook in Menlo Park and Google in Mountain View and soon to be San Jose.
How does an appraisal gap happen?
An appraisal gap means the independent report provided back to the bank shows that the house in question is not worth as much as the winning bid. Of course this is very subjective based on the comparable homes used within the report and timing of when the appraisal was performed. Appraisal reports are flawed in the sense that they are always looking backwards, but for Bay Area real estate, things can change quickly within a few months. One could argue that the real estate market is not the same back in May as it is in November, yet the appraisal report has no other comps nearby of similar size and within 6-month time frame.
For example look at these 2 homes in Los Altos.
- Home #1 sold for $2.75M on May 4, 2021 which has 3 bedroom and 2 bathrooms with 1,626 square feet.
- Home #2 sold for $2.95M Nov 18, 2021 has 2 bedroom and 2 bathrooms with 1,318 square feet.
What happens when you have an appraisal gap?
Appraisal gaps are more common than you think. Banks will state the appraiser reports are independent and therefore have no influence over appraisers in their assessment of the property in question. However, banks are almost inclined to prefer a low appraisals because the risk of defaulting on the loan becomes less risky with a lower loan amount. If you find yourself in the situation where you have an appraisal gap, here are a list of actions you can take:
- Appeal the appraisal report. This could delay your closing depending on how quickly the appeal process is performed. Expect the gap to be closed slightly but almost never completely. It might not be worth the risk if the appraisal gap is insignificant and you have the cash on hand.
- Pay the appraisal gap. For example, if your winning bid is $3.25M and your appraisal value shows the property in question as $3.1M, you will need to come up with an additional $150,000 to add to your down payment amount. The bank will subtract the appraisal gap amount from the loan amount.
- Borrow against your Roth IRA. This the solution that I was forced to use which is very creative. The rule is called the “60-Day Rule – In and Out”. You are allowed to borrow money from your IRA (Roth or traditional) without penalty as long as you put the money back within 60 days of receiving them. The action is considered as a rollover, in this case, from one account to the same account. You can only undertake this rollover once per calendar year per account. So, if you own six Roth IRAs, you can borrow from each one — abiding by the 60-day rule — once every 12 months.
Quick Summary
After several bidding wars you finally win the house but you have an appraisal gap. Appraisal reports are very subjective to the timing of when the report is done and the comparable homes utilized within the report. Appraisal gaps are pretty common especially in hot housing markets such as the Bay Area so be prepared to meet the gap.
