Appraisal Gap, Loan-to-Value, and Cash to Close
Buyer contracts to purchase a home for $350,000. Buyer is preapproved for a conventional loan at 90% loan-to-value, 30-year fixed, with PMI required above 80% LTV. The appraisal comes in at $335,000. Seller agrees to a $5,000 credit toward Buyer's closing costs. Buyer has $40,000 cash available for down payment and closing costs. Estimated closing costs are $9,500, excluding prepaids. The contract includes the Third Party Financing Addendum with a property-approval/appraisal deadline that has not yet passed. Buyer still wants the house.
1. Calculate the maximum loan, required down payment, cash needed at closing, and Buyer's shortfall.
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Lenders generally use the lower of sales price or appraised value for LTV. Here the appraised value is $335,000.
- Maximum loan: 90% × $335,000 = $301,500
- Down payment: $350,000 − $301,500 = $48,500
- Cash needed: $48,500 + $9,500 closing costs − $5,000 seller credit = $53,000
- Buyer has $40,000, so the shortfall is $13,000
PMI is still required because the loan is at 90% LTV of the appraised value. If the price were renegotiated to $335,000, the loan would still be $301,500, the down payment would be $33,500, and cash needed would be $33,500 + $9,500 − $5,000 = $38,000, which fits Buyer's $40,000.
2. What options does Buyer have before the appraisal/property-approval deadline?
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Buyer can: (1) bring an additional $13,000 to closing; (2) negotiate the price down to $335,000 or ask Seller for a larger credit; (3) seek a higher-LTV loan, such as 95%, accepting higher PMI and possibly a different approval; or (4) terminate under the Third Party Financing Addendum if property approval is not obtained by the deadline.
Buyer should not waive the financing/appraisal contingency without confirming cash and lender approval. The seller credit cannot exceed lender limits or the actual closing costs.
3. If Buyer terminates under the financing addendum because the appraisal is too low, what happens to the earnest money?
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If Buyer terminates before the property-approval/financing deadline and the lender will not approve the loan based on the low appraisal, the Third Party Financing Addendum generally allows termination and refund of the earnest money. The termination must be timely and in writing. If Buyer misses the deadline or waives the contingency, the earnest money may be at risk.