FHA Loans and the "Appraisal Gap"
June 12, 2025
For example, a buyer might agree to purchase a home for $325,000, but the appraiser, an independent third party hired by the lender, determines the fair market value is only $310,000.
This is where the "appraisal gap" factors in. The market value does not match the appraised value of the home; there is a $15,000 gap. This can be a big problem since the FHA lender will only issue a loan based on the appraised value or the purchase price. The lower amount is what the loan amount will be set at.
In this example, the lender will only finance a percentage of the $310,000 appraised value. The buyer cannot borrow the additional $15,000 for the mortgage. That money must be paid in cash at closing time.
This leaves the buyer with a few options. The first is to try to renegotiate the price with the seller.
The success or failure of that may depend on whether you're buying in a competitive housing market or not. A seller might be willing to lower the price in a buyer's market.
However, in a seller's market, where multiple offers are common, the seller has little incentive to do so. They may move on to the next offer. That leaves some borrowers in a bad spot, and it may be wise to move on to the next sale home if the seller won't negotiate.
The second option is for the buyer to cover the gap with in cash. In our example, the buyer would need to bring an additional $15,000 to closing on top of their down payment and closing costs.
Doing so is a major financial strain and may not be possible for all buyers. It means the buyer pays more than the home's professionally assessed value. Whether or not that's a long-term problem depends greatly on individual circumstances.
A third option is to walk away from the deal. FHA home loans to purchase existing construction come with an appraisal contingency, which allows the buyer to back out of the contract without penalty if the home does not appraise for the purchase price.
While this protects the buyer's earnest money, it means they have lost the money spent on the inspection and appraisal and are back to square one in their home search. But you won't be forced into a deal you don't want, and for many borrowers, that peace of mind is worth the disappointment of walking away if needed.
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