In competitive markets like the one we continue to see across Chicagoland, it’s not uncommon for buyers to offer above asking price to win the home.
When that happens, one of the first questions that comes up is, “What happens if the home doesn’t appraise for the contract price?”
Many buyers immediately assume that a lower appraisal means they must bring additional cash to cover the difference between the purchase price and the appraised value. While that can be one solution, it is not always the only option. Understanding how loan-to-value (LTV) works can create additional flexibility for buyers.
How lenders calculate loan-to-value
When a borrower applies for a mortgage, the lender calculates the loan-to-value ratio using either the purchase price or the appraised value — whichever is lower. This protects the lender by ensuring the loan is based on the property’s supported value.
What many buyers don’t realize, however, is that there may be room to adjust the loan structure if they plan to pay above the minimum downpayment and the appraisal comes in lower than expected. Here’s an example:
A home with a purchase price of $400,000 appraises for $385,000. The original financing plan would look like this:
• 20% down: $80,000
• Loan amount: $320,000
• Original LTV: 80%
Because the appraisal came in lower than the purchase price, the lender must calculate the loan-to-value based on the $385,000 appraised value. If the borrower kept the same loan amount of $320,000, the new calculation would be:
$320,000 ÷ $385,000 = 83% LTV
What changes in this scenario:
• The buyer’s down payment percentage shifts from 20% to approximately 17%
• The buyer’s cash to close remains the same at $80,000
• The buyer does not need to bring additional funds to cover the appraisal gap
In this scenario, the trade-off may be a slightly higher monthly payment or possible mortgage insurance, depending on the loan program. But most importantly, the buyer may still be able to proceed with the purchase without bringing additional cash to closing.
Why this matters in today’s market
We continue to see situations where homes receive multiple offers, and buyers are including appraisal gap language in their contracts. Understanding how financing can flex in these situations allows buyers to make stronger offers, evaluate risk ahead of time, and avoid surprises down the road. These scenarios can also be modeled before an offer is written, giving buyers clarity about what happens if the appraisal comes in below the contract price.
Tip for agents
As always, our goal at Key Mortgage is to be a financing partner that helps you and your clients navigate these situations with confidence. Encourage your clients to connect with their Key Mortgage loan officer to review potential financing scenarios before submitting an offer.