Just about every area in the United States is in a seller’s market right now, and that is especially true here in Jacksonville and on Florida’s First Coast. This type of market often leads to multiple offers on a home which can lead to bidding wars – did you just cringe a little? Is this hitting a little too close to home? We get it.
When you make an offer over a home’s list price there are some financial considerations you need to make. We’ll dive into what you, your Realtor, and your loan officer need to prepare for between making an offer, getting the appraisal done, and closing day.
Making the Offer
Before you make an offer on a home, ask your Realtor what the current average purchase to list price ratio is. In a seller’s market, this ratio will be larger than 1, or greater than 100%. This is because there are fewer homes on the market and buyers are willing to pay more to secure the home. This will tell you approximately how much over the asking price you might offer to be competitive.
For example, one neighborhood might have an average ratio of 106% or 1.06. This means that for a list price of $100,000, you can expect the accepted offer to be about $106,000. For cash buyers, the only implication is that you might adjust your shopping budget to leave more room to offer over the asking price. For buyers who are getting a mortgage, there are more serious implications to consider.
Once your offer on a home has been accepted, the lender that is financing your mortgage will often require an appraisal. This is an inspection that ensures the home is worth what the seller has asked for. Appraisals often come in close to the asking price in a typical market, either a little higher or a little lower. While appraisals do consider recent sales of comparable homes in the area, the impact will not close a gap of 6%. For our example home, the appraised value might come in anywhere between $99,000 to $102,000. This gap between the appraised value and your offer creates financial risk. Banks will not allow your total mortgage amount to exceed a certain percentage of the appraised value of your home (known in the industry as loan to value LTV).
What does this mean for you as a buyer? You’ll have to go back to the seller and negotiate the purchase price. If the seller will not come down on the purchase price to match the appraised value, you have two options: bring the difference to closing, or back out of the purchase (assuming your contract has a clause allowing you to back out due to low value).
If you have chosen to move forward with the purchase, you will need to add the difference between the appraised value and purchase price to your down payment. In our example, this means you will need to bring an additional $4-7k to the table to purchase the home. This brings your total mortgage loan amount down to the level a lender will approve and allows you to move forward with the financing.
Your Realtor or loan officer might suggest several ways to make your offer competitive. Each option comes with some risk and doesn’t eliminate the issue of a low appraisal. In a seller’s market, sales often move quickly. To make your offer more attractive, your Realtor might suggest including a clause that waives the appraisal contingency. This doesn’t eliminate the requirement for an appraisal. Instead, it says to the seller that you are committed to purchasing the home regardless of the appraised value.
When you include this type of clause, be prepared to fill the gap with additional funds or include a cap. For example, if you can bring an additional $10k to closing you might waive the appraisal contingency up to $5,000. This protects you as a buyer and makes your offer more attractive to the seller. At the end of the day, your loan officer can help you secure a great home without stretching your budget beyond your means.