When the real estate market is overheated, prices tend to rise steeply, and homes are more likely to have a problem with a low appraisal. That is where we find ourselves today in Silicon Valley as properties are selling fast, with multiple offers, few contingencies, and frequently steep overbids with resulting appraisal challenges.


Image of houses along a street with part of an appraisal report showing and the word LOW stamped on it with the words below saying "Will your home get a low appraisal?"

In the course of the last week, I’ve heard of massive overbids in much of Santa Clara County, from Alviso to Los Altos, from the lowest price points to those more than $3 million, which is generally the beginning of the luxury tier in Santa Clara County.

In Cambrian, Campbell, and other desirable but non-luxury locations, entry level and move up housing in good shape, with a good location, and not overpriced is getting a lot of attention. Some open houses are mobbed. Realtor colleagues and friends of mine are reporting that among these “normal” homes, some of the overbids are 15-25%, or $150,000 to $300,000 over list price. I heard of one, in another area of San Jose, that was 50% over list price (and it was not inappropriately priced or too low).

Together with those massive overbids are disappointingly low appraisals.

What happens with an appraisal shortfall?

Frequently, buyers with enough cash are purchasing without contingencies (we don’t recommend that, but it’s a reality that if there are a number of offers, some or all will have no contingencies). In those cases, the buyers make up any appraisal shortfall. To do so, they have far more than 20% to put down.

Hypothetical case of a low appraisal:

  • A house is listed for sale at $1 million and ends up getting 15 offers and selling for $1,275,000. (When a home sells at 27.5% over list price, there’s a good chance that there will be a low appraisal and plenty of headaches to go around for everyone involved.)
  • The buyer plans to put 20% down and have a loan for 80% and applied for a loan with those parameters.
  • The bank will lend 80% not of the purchase price, but of the appraisal value.
  • Once in contract, the buyer pays for the appraisal and the buyer’s lender hires an appraiser to make the estimate of value to ensure that the bank is not over-exposed by loaning on a property that is over-valued. The appraisal value is not the same thing as market value. If the appraised value is less than the sale price that the buyer agreed to pay, there’s an appraisal shortfall.
  • In this scenario, the buyer hopes to borrow 80% of $1,275,000, or $1,020,000.
  • Let’s say the property appraises to $1,175,000.  The bank will lend 80% of that value, or $940,000.  The low appraisal has caused an $80,000 shortfall (not the full amount of the low appraisal, but 80% of it in an 80% loan.)

Who pays for the shortfall when there’s a low appraisal?

If the ratified offer includes an appraisal contingency, the buyer can probably back out of the sale or negotiate with the seller over the gap between the planned down payment and the now much larger down payment needed to close the sale.  Back in cooler markets, I’ve seen buyers and sellers agree to split the difference. For sellers, it’s a straight loss, since the sale price goes down in that case.

If the purchase agreement has no appraisal contingency, the buyer is likely on the hook for the difference. Hence it remains true that “cash is king” because buyers with the available monetary resources can cover the larger down payment. When the buyer does this, it’s important to remember that (although it feels bad), the buyer isn’t actually paying more for the home. Instead, the buyer is putting a larger down payment in place and will have lower monthly payments. So in some cases, there’s a shift from 20% down to 25% down.

In our hypothetical case above, the buyer would be putting 26% down rather than 20% down.

What about appealing the appraisal?

I’ve not had much luck with appealing appraisals that are low, even when I can prove that the comparable properties chosen by the appraiser are inappropriate. It is very frustrating. A couple of years back I had a lovely sale with some buyers in Cambrian and the appraiser used a listed, but not sold, house next to high voltage lines as a comp. One other time, on a duplex, an appraiser used a property backing to highway 85 while my listing had a fantastic location. Just this week, though, one Realtor I know did appeal and the appraisal got adjusted upward – not as far as to sale price, but it did help.

Are there any other workarounds with poor valuations for the cash strapped?

For most buyers, this is really a math problem. Talk to your lender about setting up the loan so that you don’t use every penny you have on the down payment and required reserves so that if you need to throw more cash at the appraisal, you have the wiggle room in which to do it. If you have 20% saved, you might see if aiming at a 10% down loan would help. Or learn if there are other work arounds possible.

Alternatively, buyers, you can wait until the market cools down (the risk is that prices will be higher then, or interest rates will be higher, or both). One of my favorite solutions is simple: don’t buy the house which is getting 20 offers. Find one that’s been on the market for 3 or 4 weeks or more and is probably overpriced. If yours is the only offer, the seller and listing agent will welcome your offer – even with all contingencies squarely in place.


Related reading:

Home inspection vs appraisal

How much is your home really worth?