Can You Still Negotiate After an Appraisal?

Whenever you finance a home purchase with a mortgage, the bank is going to insist on an appraisal. An appraisal establishes the fair market value of the home, which is how the lender ensures that home is worth the price you're paying for it. What happens, though, if the appraisal comes in below the agreed-upon sales price? A low appraisal may seem like a disaster, but the goods news is, you can usually negotiate with the seller and salvage your deal.

If you're buying a home with the help of a mortgage, then the lender will send a professional appraiser around to check the home's current market value. The reason for this is to ensure the home is worth the price you're paying for it. Lenders will not loan more money than the home is worth because they won't recoup the full value of the loan if they have to foreclose and sell the property. An appraisal protects you as well as the lender, because you want to make sure you're not paying too much for the home.

Once the appraisal is complete, the bank will give you an appraisal figure. This number represents the market value of the home. It could be more than, the same as or less than the agreed-upon purchase price. What happens next depends on two things: what the home appraised for and what the contract says about appraisals.

If the house you're buying appraises higher than what you've agreed to pay for it, then this is definitely a good thing. The bank will lend the amount you're qualified for and you can proceed to closing knowing you've just got yourself an additional benefit in the form of instant equity. The seller doesn't get a copy of the appraisal report, so the best advice is to keep the high appraisal private, keep the deal on track and close as soon as you can.

More likely, the appraisal will come in the same as the purchase price. Understand that the appraiser knows the contract price before she visits the property. While she obviously is appraising the market value of the property, she's also figuring out whether she can justify the sale price. Unless the price you've negotiated is way off, the appraiser likely will come back with a matching figure most of the time.

Where you run into trouble is if the home appraises lower than the offer price. No lender will give you more than the maximum "LTV" for the property, which means the mortgage you're getting will be reduced based on the low appraisal value. LTV stands for loan-to-value, and it's a ratio of how much mortgage you're getting in relation to how much the property is worth.

For instance, an LTV of 80 percent means the bank will lend no more than $320,000 on a $400,000 home. You have to come up with the remaining $80,000 from your own pocket in the form of down payment. But if the house appraises lower at, say, $380,000, then suddenly the bank will only lend $304,000 to maintain an 80 percent LTV. You now have to come up with $96,000 from your own funds.

More worryingly, you'll be paying more for the home than it's actually worth, which means you'll be in a negative equity state from closing. You have three options in this situation:

• Stick with the same deal (a price of $400,000), take the lower mortgage offer ($304,000) and make up the difference yourself.
• Walk away from the deal entirely (which you may be able to do depending on the terms of the contract).
• Negotiate a reduced price with the seller.

As with any type of real estate problem, the first place to look for answers is your contract. Most standard real estate agreements contain a list of conditions, known as contingencies, which have to be satisfied before the purchase can be finalized. One standard contingency is the appraisal contingency. The wording may vary but, in most cases, the contingency states that a low-ball appraisal can make or break the deal.

In other words, if the appraisal comes in lower than the offer price, you have the right to cancel the contract without penalty. This puts you in a strong negotiating position. With a low appraisal, if the seller won't budge on price, then you're entitled to walk away and force the seller to re-list the property.

In reality, a low appraisal is rarely a deal killer. Most sellers are willing to negotiate because the alternative is the contract falling through and the seller having to put the house back on the market. This can be frustrating to everyone involved – and there's no guarantee that the next buyer's appraisal will come in any higher.

When negotiating with the seller, remember that neither of you is obligated to agree to a reduced price. The seller can stick to the offer price and force you to make the call about whether to cancel the contract. The success of the negotiation really depends on the financial position of the parties and how much you both want the sale to go through.

Similarly, there are no rules about how you negotiate, or what kind of price reduction you ask for. Ideally, you'll want to drop the price down to the appraised value. But if the seller is reluctant, it could make sense to split the difference, with the seller dropping the price a bit and you adding cash to your down payment. For instance, if the difference between the offer price and the appraised value is $20,000 as in the above example, then you could negotiate the price to $390,000 so you're both taking a $10,000 hit.

If there's no appraisal contingency, then you're in trouble. Without the protective wording, you can't legally back out of the contract and you must complete the sale. The original sale price ($400,000 in this example) will still stand and you'll need to find the additional $16,000 from your own pocket.

You could still try to negotiate the price down, but this time, you're in an extremely weak bargaining position. The seller knows you can't cancel the contract and he can sue you if you refuse to close the deal. It's extremely difficult to negotiate a price reduction in this situation, because there's no incentive for the seller to meet your demands.

If you're caught in this position then the best option may be to get a second appraisal. As highly experienced as appraisers are, mistakes do happen. There's always a chance that your appraiser got the numbers wrong. Ask to see the comparables – that's the sales prices of similar properties that the appraiser based his calculations on. If the numbers look wrong, you can always give a second roll of the die in the hopes of a better outcome.