Loan-to-Value Ratio, Mortgage Insurance, Appraisals, and Appraisal Gaps

Buyers and sellers of real estate should understand key financing concepts like the Loan-to-Value Ratio (LTV), appraisals, appraisal gaps, and appraisal gap coverage. These elements often determine whether a transaction closes smoothly—or falls apart.

Loan-to-Value Ratio (LTV)

When approving a mortgage, lenders carefully consider the Loan-to-Value Ratio (LTV). The LTV reflects the lender’s risk and is calculated as:

LTV = Loan Amount ÷ Property Value

For example, if a home is valued at $500,000 and the buyer makes a $100,000 down payment, the loan amount would be $400,000. The LTV would then be 80% (loan) / 20% (equity).

Lenders typically hire independent appraisers to determine the property’s fair market value before final loan approval. If the home doesn’t appraise at or above the contract price, the loan may be at risk because the LTV no longer meets the lender’s requirements.

Mortgage Insurance

Many buyers are familiar with LTV because it can directly affect their monthly payments. If the down payment is below 20%, most conventional loans require private mortgage insurance (PMI), which protects the lender in case of default or a decline in property value.

Not every borrower needs mortgage insurance. For instance, VA loans don’t require PMI because the U.S. Department of Veterans Affairs guarantees a portion of the loan. FHA loans, on the other hand, require a Mortgage Insurance Premium (MIP), regardless of down payment size.

What Is an Appraisal Gap?

An appraisal gap occurs when the agreed-upon purchase price is higher than the appraiser’s valuation. This creates a shortfall that throws the LTV out of balance.

When this happens, the buyer, seller, or both must find a way to bridge the gap—or the loan will not fund.

Scenario 1: Multiple Offers and Over-List Bidding

Joe and Sally fall in love with a home listed at $500,000. To beat out competing buyers, they offer $550,000.

The listing agent warns the seller that the home may not appraise for the full contract price but advises asking the buyers to commit to appraisal gap coverage. The seller counters that the buyers must cover up to $50,000 of any shortfall.

Joe and Sally agree to cover $25,000, and their offer is accepted.

How this plays out:

• The appraiser values the home at $525,000—$25,000 below the purchase price.

• Because Joe and Sally agreed to cover up to $25,000, they must bring that extra amount to closing in addition to their down payment.

• This ensures the lender’s LTV requirements are satisfied and the loan can close.

Scenario 2: Seller Overpricing and No Gap Coverage

A seller lists their home for $600,000—well above comparable sales in the area. Joe and Sally offer full list price, hoping the upgrades justify the premium.

How this plays out:

• The appraiser values the property at $575,000—$25,000 below the contract price.

• With no appraisal gap coverage in place, negotiations must happen. The seller may agree to lower the price, or the buyers might increase their down payment to cover the shortfall.

• If no agreement is reached, the lender will not fund the loan. As long as the buyers kept their appraisal contingency, they can walk away and recover their earnest money.

Key Takeaways

• For Sellers: Accepting an offer with appraisal gap coverage reduces the risk of having to lower the price later if the appraisal comes in low. Overpricing still carries risk, as lenders may not support inflated values.

• For Buyers: Offering gap coverage can strengthen your offer in a competitive market, but it comes with financial risk. Only agree if you have the liquid funds to cover a potential shortfall.

• Appraisal Contingency: Buyers should think carefully before waiving this protection. Unless you’re prepared to cover the gap with cash, it’s wise to keep the appraisal contingency in place.

All Rights Reserved Sam Densmore/September 2, 2025