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With tens of thousands of homebuyers bidding far above list prices, lenders have seen a surge of cases where the offer price is greater than the property value. Or at least, greater than the property value as judged by a bank appraiser.

“We’ve seen a rise in the number of appraisal reports with values below the purchase price, and estimated value for refinances,” says Christopher Bisson, founder and chief executive of Value Connect, an appraisal management company.

In almost half the cases where a property sells for more than the appraised value, he sees mortgage advisers asking realtors to search for recent comparable sales that support the higher value.

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Mark Ostland, director of mobile experience at Meridian, Ontario’s largest credit union, has also seen a spike in properties that don’t appraise for the purchase price, compared with 2020. He estimates that 10 per cent to 20 per cent of Meridian’s Toronto deals fall in that category.

What could go wrong?

Overbidding on a home purchase carries at least four risks, Mr. Ostland says.

  • An insufficient appraisal could make your down payment too small and/or your debt service ratios too high, meaning “your approval is now a decline” – if you don’t have other resources.
  • You be forced to dip more into your savings. That could mean tapping “RRSP assets, vacation money or even going back to Mom and Dad.”
  • You might have to shed debt or come up with more income, by using a co-signor, for example. “We’re seeing an influx of deals with multiple applicants,” Mr. Ostland says.
  • Worst case, you may have to walk away. In that scenario, “at a very minimum the seller is going to keep the deposit,” assuming you didn’t have a condition that lets you out of the deal. You could also face legal action for breach of contract, especially if prices drop and the seller can’t get what you offered from someone else.

Mr. Ostland cites an example in which a Toronto-area couple bid $1.6-million for a property and the appraisal came in at just $1.4-million. They had no other resources to make up the difference between the originally anticipated mortgage amount and the lower, revised mortgage the lender was going to give them. But, fortunately, they were smart enough to make their purchase subject to financing, so they were able to back out and not lose their deposit.

“In this market you’re going to have multiple buyers,” Mr. Ostland says. So it’s not surprising that almost three out of four Toronto houses sold over asking in April, according to Realosophy. The average sale price was 7 per cent more than list price – compared with 1 per cent more in April, 2019. Of course, part of that is because realtors are purposely underpricing homes to generate interest.

In hypercompetitive markets, the offer that is accepted most often has no conditions, he says, something Meridian Credit Union cautions borrowers against.

“Our recommendation is to have a financing condition. In reality, it’s tougher if you really want the home ... but protecting yourself is number one.”

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Instead, sweeten your offer in other ways such as agreeing to the seller’s preferred closing date, submitting a mortgage preapproval with the offer, having the appraisal within 48 hours and making a larger than normal deposit.

Mr. Ostland cites another example outside the Greater Toronto Area where an appraisal came in $25,000 under the purchase price. “The buyer and seller came together to make it work.” The seller came down $10,000 and the purchaser ate the rest. Sharing the difference was possible only because the buyer’s financing condition gave him leverage.

Have a Plan B

Overpaying is fraught with risk in any market, let alone a market where average home values are up a record 41.9 per cent nationally in just 12 months.

Those paying significantly over list price need a foolproof backup plan. Here’s an example that shows why:

  • You have exactly $210,000 for a down payment
  • You offer $1.05-million on a home
  • The home appraises for $100,000 below what you paid

In this case, a mainstream lender would only approve a maximum $760,000 mortgage (80 per cent of the $950,000 appraisal).

That means you’d have to come up with $80,000 more ($290,000 total) to bridge the gap between the $1.05-million you agreed to and the maximum mortgage amount.

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Borrowers who know they’ll be able to put down at least 20 per cent regardless can technically take more chances.

But, if you’ve got only the minimum required down payment (5 per cent to 7.5 per cent), don’t even ponder buying in this market, unless you have: a financing condition or a way to come up with more cash if the property appraisal is less than the sale price.

And don’t forget, mortgages with less than 20 per cent down require two parties to approve you, the lender and the default insurer. If either of them isn’t comfortable with the risk of a property – valuation risk or otherwise – you may be caught without a financing clause.

That’s a key point for someone getting a preapproval. The reason? Appraisals aren’t done on preapprovals, and your application generally won’t be sent to the insurer. Those things happen only after you sign a purchase agreement.

If there’s a theme here, it is this: Know your limit and buy within it.

Nothing haunts you like the house you didn’t get, some realtors like to say. But let me tell you, buyer’s remorse is pretty haunting in its own right.

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Robert McLister is mortgage editor at RATESDOTCA and founder of and intelliMortgage. You can follow him on Twitter at @RateSpy.

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