The Appraisal Gap and the Seller Concession
Buyers are preapproved for a 30-year conventional loan at 6.5% and have $34,000 in verified funds. They sign a purchase agreement for $286,000 and intend to put 10% down. Closing costs are estimated at $6,200 and prepaid escrows for taxes and insurance at $2,100; the seller customarily pays Michigan transfer tax. The appraisal comes in at $271,000. The buyers' gross monthly income is $7,400, with a $415 car payment and a $180 student loan payment. Annual taxes are $3,600 and hazard insurance is $1,320. PMI at 0.5% of the loan balance will apply. The buyers ask their agent whether a 3% seller concession can close the gap and whether they can still buy the house.
1. Compute the loan amount, the cash required to close, and the shortfall.
Read the worked answer
Loan amount. Lenders lend against the lesser of the contract price or the appraised value. 90% x $271,000 = $243,900. (Not 90% of $286,000, which would have been $257,400.)
Cash to close:
- Down payment: $286,000 price - $243,900 loan = $42,100
- Closing costs: $6,200
- Prepaid escrows: $2,100
- Total: $50,400
Shortfall. $50,400 - $34,000 = $16,400.
Frame it for the buyers. The $15,000 appraisal gap ($286,000 - $271,000) is only part of the problem; the extra cash requirement also includes the difference between 10% of the price they planned on and 90% of the appraisal. Even a full price reduction will not fully solve a cash problem this size.
Transfer tax note (seller's side). Michigan state transfer tax is $3.75 per $500 of consideration, rounded up to the next $500: $286,000 / 500 = 572 units x $3.75 = $2,145, plus any county tax. A renegotiated price changes this figure; the buyer's agent should not quote it as the buyer's cost without confirming the local custom in the contract.
2. Will a 3% seller concession close the gap? Explain the mechanics and the alternatives.
Read the worked answer
Concessions cannot create value. Interested-party contribution caps at 90% LTV for a one-unit primary residence are well above 3% (the 6% tier applies at 90% LTV), so $8,130 in concessions is within the cap - but the cap is not the binding constraint. Concessions cannot:
- raise the appraised value, so the loan stays at 90% of $271,000 = $243,900;
- be applied to the down payment or the appraisal gap;
- be used for the buyer's minimum contribution where the program requires one.
If the price is raised to $294,130 to 'fund' the concession, the lender still uses the $271,000 appraisal, so the buyer's cash requirement rises rather than falls. The idea fails on mechanics.
Workable alternatives:
- Renegotiate the price to $271,000. Down payment becomes $27,100; total cash $35,400 - still about $1,400 short.
- Renegotiate price and request a repair credit toward the foundation, so cash goes to the gap instead of repairs.
- Documented gift funds from a family member for the down payment and closing costs, with the lender's gift letter and paper trail.
- Restructure with a smaller down payment only if the program permits it - 90% financing is already near the conventional ceiling without mortgage insurance changes.
What the agent must not do: advise the buyers to waive the appraisal contingency or promise the seller will 'make it work.' Present the numbers, let the buyers choose, and recommend they speak with their lender and attorney.
3. Using the $243,900 loan, evaluate whether the buyers qualify on income, and identify what is actually blocking the purchase.
Read the worked answer
Principal and interest. Monthly factor at 6.5% for 30 years is $6.3207 per $1,000. $243,900 / 1,000 = 243.9 x $6.3207 = $1,541.62.
Other housing costs:
- Taxes: $3,600 / 12 = $300.00
- Insurance: $1,320 / 12 = $110.00
- PMI: 0.5% x $243,900 / 12 = $101.63
- Total housing payment: $2,053.25
Front-end ratio: $2,053.25 / $7,400 = 27.7% - inside the conventional 28% guideline.
Back-end ratio: other debt $415 + $180 = $595. ($2,053.25 + $595) = $2,648.25 / $7,400 = 35.8% - inside the 36% manual guideline, and comfortably inside automated underwriting ranges.
What is actually blocking the purchase. Not income and not credit - it is liquidity plus an appraisal gap. The buyers qualify for the payment they would make, but they cannot produce the $50,400 the transaction now requires against $34,000 available ($16,400 short, or roughly $1,400 short if the price is renegotiated to the appraised value).
How to advise: say plainly that the barrier is cash, not qualification. Present the price-reduction scenario with real numbers, confirm the renegotiated transfer tax and proration impacts at closing, and keep the appraisal contingency intact unless the buyers affirmatively decide otherwise in writing. A licensee may explain financing math but should not direct the buyers into a specific loan product.