Appraisal Gap, Seller Credit, and Cash to Close
Buyer has a conventional 95% LTV preapproval at 6.75% for 30 years. Purchase price is $340,000; the appraisal comes in at $325,000. The seller will not lower the price but will credit $6,000 toward buyer closing costs. Buyer has $20,000 cash. Estimated closing costs are $9,500; prepaid items and escrows are $3,000. PMI is required until the loan balance reaches 80% of the original value. The lender uses the lower of purchase price or appraised value to set the loan. The buyer asks the broker whether to “just finance the gap” by raising the price to $355,000 with a $15,000 seller credit.
1. Calculate the maximum loan, buyer cash needed, and cash shortfall using the appraisal.
Read the worked answer
The lender uses the lower value, so the loan is based on $325,000:
- Maximum loan: 95% × $325,000 = $308,750
- Buyer’s equity/down payment: $340,000 − $308,750 = $31,250
- Cash to close: $31,250 + $9,500 + $3,000 − $6,000 seller credit = $37,750
- Buyer has $20,000, so the shortfall is $17,750.
The $15,000 appraisal gap is effectively paid by buyer because the seller will not reduce the price. The buyer cannot close on the stated cash unless the price, loan structure, or credits change.
2. Why does raising the price to $355,000 with a $15,000 seller credit not solve the appraisal gap?
Read the worked answer
Raising the contract price does not raise the appraised value. The lender will still use $325,000, so the maximum loan remains $308,750. A higher price increases the buyer’s equity requirement rather than reducing it.
Seller credits are also limited. At 95% LTV, conventional limits on interested-party contributions may cap the credit at 3% of the price; $15,000 on a $355,000 price is about 4.2% and likely exceeds the cap. Credits generally cannot cover the down payment or appraisal gap. Inflating the price to disguise the gap can also create mortgage-fraud risk. Better options are reducing the price to $325,000, bringing more cash, changing loan terms, or renegotiating.
3. If the price were reduced to $325,000, what would the buyer still need, and what should the broker say about PMI?
Read the worked answer
At a $325,000 price, 95% financing gives a $308,750 loan and $16,250 down. Cash to close would be $16,250 + $9,500 + $3,000 − $6,000 = $22,750, leaving a $2,750 shortfall against the buyer’s $20,000.
PMI is required because the loan is 95% LTV. The original value for PMI purposes is the lower of price or appraised value at origination, here $325,000. Borrower may request cancellation when the balance reaches 80% of that original value under the amortization schedule, and automatic termination is generally at 78%, subject to lender rules. The broker should not suggest misrepresenting the price or appraisal; the buyer should compare bringing cash, a lower LTV loan, or renegotiating the price and credit.