In multiple offer situations, in order to win, buyers often have to be willing to offer to bridge a gap between the appraised price of a property and the purchase price in case if the property doesn't appraise for the purchase price. So what does bridging an appraisal gap mean exactly?
First, you have to understand what an appraisal is. Click here to read more about what an appraisal is exactly. Please note that typically appraisals only occur when you're getting a loan to buy a property. If you're paying cash, most home buyers don't order an appraisal as typically appraisals are only done by a bank when a buyer is getting a loan as the bank wants to make sure their investment (in this case, the house) is worth what the buyer is paying for it.
When purchase prices go up a lot above fair market value, such as in a hot housing market, sellers often get concerned that the property won't appraise for the high purchase price. If it doesn't, then the bank won't give the money to the buyer for the buyer to buy the property at the agreed upon purchase price so that's why many sellers want buyers to offer to bridge appraisal gaps in cash.
For instance, if a property's agreed upon purchase price with the buyer is $525,000 but the property only appraises for $500,000 then the bank will only give the buyer a loan to buy the property for $500,000 including the down payment the buyer is planning to pay. That means there is a $25,000 gap between what the bank will allow the property to be purchased for and the contract price of $525,000. When that happens there are three options:
1. The seller can drop the price to $500,000 and the deal can go forward
2. The buyer can agree to bring $25,000 extra in cash to the closing on top of their down payment and closing costs to bridge the gap between $500,000 and $525,000 in cash so the seller is still getting their full $525,000
3. The buyers and sellers can negotiate a new purchase price such as $515,000. In that case the buyer brings an extra $15,000 in cash to the closing beyond their down payment and closing costs and the seller only gets $515,000 for the property rather than the originally agreed upon $525,000.
Basically offering to bridge an appraisal gap in cash before an offer is accepted lays out what will happen if the property doesn't appraise up front so there's no questions or renegotiating later if the appraisal comes in low. Usually how this works is that the buyer says as part of their offer that they will agree to bridge up to X dollars in cash if the appraisal comes in low. This can range from $1,000 to $100,000 or more and some buyers offer a blank check saying they'll bridge any amount in cash no matter how low the appraisal comes in at.
So say a buyer and seller agree that the buyer will bridge up to $20,000 in cash if the property doesn't appraise for the purchase price before an offer is accepted. In this scenario let's say the purchase price was $525,000 and the appraisal then later comes back at $500,000. The new purchase price would be $520,000 as the buyer had agreed to bridge up to $20,000 in cash. So the buyer would bring $20,000 extra in cash to the closing on top of their down payment and closing costs and the seller would agree to lower the price to $520,000.
It is very common in multiple offer situations to need to add appraisal gap coverage as sellers want a guarantee they are going to get the purchase price you offered. The question simply becomes how much are you willing to bridge up front in cash if the property doesn't appraise for the purchase price?