The $405,000 Appraisal on a $420,000 Contract
Dana is pre-approved for a conventional 30-year fixed loan at 6.875% with a maximum 85% loan-to-value. She is under contract on a $420,000 house with 15% down. The lender's file shows annual property taxes of $3,150, hazard insurance of $1,800, an HOA of $45 per month, and no mortgage insurance at 85% LTV. Dana's gross monthly income is $9,400; she pays $415 on a truck loan, $180 in student loans, and a $95 credit-card minimum. The appraisal comes in at $405,000. The contract has no appraisal-gap clause and a financing contingency expiring in ten days. Dana's agent tells her, "Don't worry, we'll just ask the seller for a credit."
1. Compute the monthly housing payment and Dana's debt ratios. Does she qualify?
Read the worked answer
Loan amount: $420,000 × 85% = $357,000
Principal and interest: i = 6.875% ÷ 12 = 0.00572917; n = 360; payment factor ≈ 0.0065695 $357,000 × 0.0065695 ≈ $2,345/month
Full housing payment (PITI + HOA):
- P&I: $2,345.00
- Taxes: $3,150 ÷ 12 = $262.50
- Insurance: $1,800 ÷ 12 = $150.00
- HOA: $45.00
- Total ≈ $2,802.50
Ratios:
- Front-end: $2,802.50 ÷ $9,400 = 29.8%
- Other monthly debt: $415 + $180 + $95 = $690
- Total: $3,492.50 ÷ $9,400 = 37.2%
Judgment: On classic 28/36 guidelines she fails both tests. In practice, an automated underwriting system will often approve to 45–50% DTI with compensating factors (reserves, credit score, stable income), and 29.8/37.2 is not extreme. But the licensee should not tell Dana she 'qualifies' - that is the lender's determination. The agent's job is to flag the thin margin and confirm the lender has actually run the file at 37.2%, not at the payment the agent guessed.
2. Quantify the appraisal gap and lay out Dana's realistic options.
Read the worked answer
The gap: $420,000 contract price − $405,000 appraised value = $15,000.
Why it matters: LTV is calculated on the lesser of price or appraised value. At 85% of $405,000, the maximum loan is $344,250, not $357,000 - a $12,750 shortfall in loan proceeds.
Cash required now:
- Down payment: 15% × $405,000 = $60,750
- Plus the $15,000 gap = $75,750
- Versus the $63,000 she planned = $12,750 more cash, before closing costs.
Options, with the math:
- Renegotiate to $405,000. Loan $344,250 + down payment $60,750 = $405,000. Her cash need actually drops to $60,750. Best outcome if the seller will move.
- Bring $12,750 extra cash and keep the $420,000 price. Viable only if she has verified reserves; she must not drain them.
- Piggyback or second lien to cover the gap - higher blended rate; she must re-qualify at the new payment, which pushes DTI above 37.2%.
- Challenge the appraisal with better comps if the appraiser missed the 480 sq ft or a superior feature.
- Terminate under the financing contingency - but only if the contingency is actually written to protect her when the appraisal fails to support the price. Read the clause; do not assume.
Days remaining matter: the financing contingency expires in ten days. Options 1, 2, and 5 all require written action before that date.
3. Does a 3% seller credit solve the problem?
Read the worked answer
No - it solves a different problem.
A seller credit is applied to the buyer's closing costs; it does not change the appraised value and does not raise the loan cap. The lender will still lend no more than 85% of $405,000. The $12,750 equity shortfall remains.
The numbers: 3% of $420,000 = $12,600. That money can offset title, lender, and prepaid costs, but it cannot be converted into loan proceeds, and credits cannot exceed the actual closing costs - excess credit is typically lost, not handed to the buyer.
Concession limits still apply. At 85% LTV the customary seller-concession ceiling is well above 3%, so the credit is permissible - it is simply aimed at the wrong line item. Verify current agency guidelines before quoting a limit.
What to say to Dana: her agent's reassurance is technically wrong and, said to a buyer under deadline pressure, edges toward misrepresentation. The correct script is: 'The credit can help with your closing costs. It cannot close the appraisal gap. Here are the four ways this gets solved, and here is the deadline.'