How To Stay Competitive In Vermont’s Real Estate Market With Appraisals That Come Up Short

Key Takeaways

• The market is competitive and in the sellers’ favor, but buyers can be competitive with their mortgage to make their offer more appealing.

• When there is an appraisal gap, you can: include an appraisal contingency (to prevent overpaying), renegotiate (which can be tough in today’s market), or include an appraisal bridge in your offer (which means you’ll cover the gap up to a certain amount). 

• Saving money where you can now gives you flexibility in this market. Knowing where your mortgage stands will make you better prepared to make an offer.
   

It’s no secret that the Vermont real estate market is advantageous to sellers. Low inventory and historic demand mean buyers need a highly competitive offer just to be considered. The current real estate market is leaving many buyers frustrated, but at Vermont Real Estate Company we stress to our buyers to not get discouraged. Earlier this year we predicted price increases would slow down, and while prices aren’t going to drop, there is some stability coming to the market. If buyers can’t waive inspections and appraisals or make an all-cash offer the frustration may feel overwhelming. But there are a few things buyers should know about their real estate mortgage that will both prepare them for the competitive buying process and make their offer more appealing to sellers. Understanding your options and having the right expectations will help you through the process. You can have a winning offer, you just need to be prepared and strategic. 

We sat down with Nick Parent from Vermont Mortgage Company to chat about mortgage options in today’s market. Keep reading to learn how to be competitive with your mortgage.

Appraisals in the Current Real Estate Market

First of all, why are appraisals important and even necessary? Real estate agents, lenders, and appraisers will compare the home you made an offer on with comparable homes in the area, these are also known as ‘comps’. At Vermont Real Estate Company, our agents always analyze the comps with a comparative market analysis (CMA) for both buyers and sellers. The CMA is used to prove the listing price is fair market value, ensuring sellers are getting what the market will bear and buyers aren’t overpaying. Banks and lenders look to appraisers to confirm the fair market value of the home. They won’t let buyers borrow more than the home is worth because if a homeowner defaults on their mortgage, the lender wants to make sure they can cover the loan using the house as collateral. Cash buyers don’t have to worry about appraisals, but for most Vermont home buyers, all-cash offers aren’t an option.

A problem we’re seeing in fast-moving real estate markets like the one we’re experiencing in Vermont is that appraisers can’t keep up with price increases. Listing prices are rising quickly and a similar home in the neighborhood might have sold for $25,000 less just a few months ago. It’s understandable why an appraiser might not have enough comps to confirm a sellers’ asking price considering the low inventory. This means that appraisals are coming in lower than the listing price. This is known as an appraisal gap. 

How Appraisal Gaps Impact Your Mortgage

Lenders, like Vermont Mortgage Company, use a ratio to help determine how much a buyer can borrow. This ratio is known as Loan to Value or LTV. Loans with a higher LTV are considered riskier by lenders and therefore come with stricter requirements. With a standard 20% down payment, the LTV is 80%. Typically, an LTV over 80% will require that a borrower purchase private mortgage insurance (PMI). PMI is an additional cost that protects the lender and doesn’t add equity to your home. Often buyers look to avoid PMI if possible. 

Here’s a scenario to help understand how appraisal gaps impact your mortgage and how you can prepare to make a great offer:

Sam and Kristine found a charming, 2 bedroom home with a listing price of $300k. They make an offer for the listing price with a 20% down payment worth $60k. When they make their initial offer, the LTV is based on the offer price. 

Offer Price: $300k
Deposit: $60k
Loan Amount: $240k
LTV = 80%

When they met with their Vermont Real Estate Company agent to make an offer, their agent helped them understand that the latest comps for 2 bedroom homes in the area were closer to $280k and there was a chance there would be an appraisal gap. Their lender gets a third-party appraisal to confirm the market value for the home. After the appraisal, LTV is based on whichever is lower, the offer or the appraisal. The appraisal comes in at $290k, $10k below the listing price. 

Offer Price: $300k
Appraised Price: $290k
Loan Amount: $240k
Deposit: $60k
LTV = 83%

This means that the bank will only lend a maximum of $232k, and, with an LTV of 83%, they now need to include mortgage insurance in their monthly payments. If they aren’t comfortable with the additional payments they’ll need to find a way to avoid PMI. Do they simply have to cover the $10k difference? Not necessarily. The buyers only need to pay 80% of the difference to bring them back to 80% LTV.

Offer Price: $300k
Appraised Price: $290k
Loan Amount: $232k
Deposit: $68k
LTV = 80%

So what can Sam and Kristine do with an appraisal gap?

Include an Appraisal Contingency

Appraisal contingencies protect buyers when an appraisal comes up short. If Sam and Kristine include this contingency in their offer, they can walk away from the deal if the appraisal comes in below the offer price. If the charming 2 bedroom isn’t the home of their dreams and they have flexibility and patience to move, then this protects them from overpaying. But, in today’s market, an offer with an appraisal contingency stands little chance with multiple offers in the sellers’ hand. They must be comfortable losing to a stronger offer with fewer contingencies.

Renegotiate with the Seller

Like an appraisal contingency, renegotiating in Vermont’s hot real estate market is unlikely to be successful. Sellers have significant leverage with multiple backup offers. Talk with your Vermont Real Estate Company agent to understand if there is any room for negotiation. If a home has been on the market for a significant period of time or doesn’t have the expected number of offers, you may have a chance to come down to match the appraisal.

Include an Appraisal Bridge

According to Nick, an appraisal bridge is a helpful tool that you can include in your offer that lets the seller know that in the event an appraisal comes up short, you will cover the difference up to a certain amount. Sam and Kristine understand that the latest comps mean it’s likely the appraisal will come in lower and have enough cash on hand to cover the 80% difference up to $10,000. The appraisal bridge gives the seller confidence that the deal won’t fall apart. To help, buyers that use an appraisal bridge should include proof of funds to demonstrate they can cover the gap. 

Sam and Kristine knew there was a good chance that the appraisal would come under the listing price. They had an extra $8k in the bank and are able to include an appraisal bridge to cover 80% of the $10k difference. This helps them stand out against weaker offers with higher LTV ratios and additional contingencies.
 

Final Thoughts

So the key to being a successful buyer when you don’t have hundreds of thousands in the bank is to save money where you can. This will give you extra flexibility when it comes time to make an offer with higher down payments, the ability to pay for mortgage insurance or add an appraisal bridge to your offer.  If you’re looking to buy a home and aren’t sure where to start, connect with our friendly and knowledgeable agents. They will help guide you through the home buying process and can make sure you’re making a competitive offer that is within your means. 

Stay tuned for the next article in our Competitive Buying Series: Interest Rates - What You Need to Know.