I just got a call from one of our home buyers about a home she is buying in Woodbury, Minnesota. She wants to buy a bank owned home – more commonly known as a Real Estate Owned (REO) property. The bank accepted her purchase agreement for the purchase price of $196,000. This was a multiple offer situation and she felt lucky on getting her offer accepted. She wants the home as it is near her parents home.
The reason for her call to me was that the mortgage company she is using for her new loan, just notified her and said their appraiser valued the property at $189,000. This is a decrease in value of $7,000. She asked me if the Seller, in this case the bank, would lower the purchase price to match the lower appraised value.
The quick answer is; it depends on what had been agreed to in writing in the purchase agreement.
Most lenders on purchases will lend only the percentage they have agreed to lend of the appraised value of the home, if it is less than the purchase price. That is, if the lender has agreed to extend an 80 percent loan-to-value mortgage (i.e., a loan in which the buyer puts down 20 percent), that lender is actually only approving a loan for 80 percent of the appraised value of the home.
Until around 2006, it was common for the appraised value of a home to equal or even exceed the purchase price, so the issue of a low appraisal was a rare one.
Around 2007, home values started to decline and appraisal and lending standards began to tighten. Now — the situation in which the appraisal comes in below the purchase price that buyer and seller have negotiated — has become so common that in a recent survey of real estate brokers and agents, 40 percent said that a low appraisal or other appraisal-related glitch has caused the undoing of at least one of their recent transactions.
You wonder, why doesn’t the seller just drop the price? Many sellers are already so close to the bone on their sale price compared to what they owe on their mortgage and closing costs that they stand to recover nothing after the sale in the first place. Reducing the price would doom them to either pay money to close the deal (which they may not have) or to turn the transaction into a short sale, which neither the buyer nor the seller wants, in most cases.
It is very common in multiple-offer situations on bank-owned properties for the seller (the bank) to require the buyer to agree upfront to pay the difference that their lender won’t, if the place appraises low — especially if the offered price is above the asking price.
Some smart individual homeowners who receive multiple offers will discourage buyers from bidding high just to win the war on the assumption they’ll be able to come back and get the price reduced when it doesn’t appraise by requiring them to sign such a clause.
And yes, this is legal, as long as the buyer agrees. To summarize the long story, the wording in the purchase agreement will dictate if the Buyer can back out of a purchase agreement as the result of a low appraisal. Be sure to get the advice of your seasoned real estate agent on the best terms for your situation.
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