How much is that house really worth? Appraisals in the Home Purchase Process

So it’s time for the appraisal.  An appraiser is someone that is hired by the buyer but essentially works for the lender to investigate the property.  Most importantly, an appraiser determines the value of the property as security for the loan that you (the buyer) are going to get on the property.


Why is the Appraisal Important?

If a bank is going to lend several hundred thousand dollars, they want to make sure that if things go badly and you decide not to pay the mortgage – there’s an asset worth the amount of money they lent you.  And depending on the loan, and the amount of down payment that particular loan requires, it really would have to be enough to recover the loan balance.  So if you offered $300,000 but the loan is for $270,000, the lender wants to know that the property’s worth enough to clear $270,000 if you defaulted on the loan.

The Inspection

When an appraiser goes out to examine a property, they are going to do a cursory inspection.  Certainly nothing as thorough as a home inspector is going to do but they are going to look at the general condition of the property and notate any issues they identify.  If they clearly see that there is damage to the property, it is going to be identified.  If they can see evidence of something such as dry rot, it is going to be noted by the appraiser and reported back to the lender.  If the loan requires these issues be addressed then it has to be corrected before the lender will fund the loan.  Now the appraiser is going to make a fairly quick pass during their inspection on the property.  They’re likely to measure the dimensions, confirm the size (square footage) of the property and check the overall condition of the property.

The Research

The rest of what they do is look at recent sales of nearby houses that are similar so they can compare features, amenities and prices.  The most important thing they are doing is determining the value of that property – and if in fact that value would support that loan.  So they’re going to “run comps” – look at comparable properties to see if the value of other recently sold properties support the offer amount and the loan amount that you have for this property.  Therefore, a report from the appraiser will usually show 3 primary comparable properties and begin to make adjustments up and down depending on what features and amenities this property has in contrast to another.  For example, if your home, the home that the buyer is purchasing, has a pool but is very similar to the house next door that sold several months ago but didn’t have a pool, they’re going to make adjustments for that.  The appraiser is going to take several properties (at least three) and start making financial comparisons based on what one property has versus another.  Ultimately, they will be able to say this property is worth – in their estimation – this amount.

The Final Report

Now if a property does not appraise for the contract price – for example, you offer $400,000 and the appraisal comes in at $390,000 – In most contracts there is a contingency for you to exit the contract (although a good idea to check with your agent when writing an offer).  More on contract contingencies.  The appraiser is simply giving an opinion – now it is a well-educated opinion – so it’s likely to be a good opinion.  But it is still an opinion of value.  However, when you have a property that doesn’t come in at contract value, there are a few things that can be done.

Appraisal2What Are Your Options?

The lender is going to object to the $10K difference because they’re willing to lend on the appraised value.  For example, in a FHA loan, if they are willing to lend up to 96.5% of the appraised value they are going to re-calculate your loan based on the $390K value which leaves roughly a 10K gap.  So what’s the solution in that instance?  Well, you’re going to want to talk to your broker but one of the first likely answers would be to ask the seller to bring the price down to  the likely true value of $390K – which the seller may or may not do.  Another option is you could pay the difference if you have the cash – lenders will generally allow that.  Or perhaps you can find something in the middle – and that is something that would be negotiated between the buyer and the seller of the property.  If you have an appraisal contingency intact you can always cancel the contract without penalty (aside from the cost of the appraisal, any intersections or other non refundable expenses made).

An appraisal, like a home inspection, really protects everyone involved… especially the buyer and the bank.  It can be very reassuring to have an expert opinion confirming you are paying a reasonable price on a house, especially if there are unusual qualities to a property or you are worried that you might be overpaying.  That said, an appraisal is an opinion and nothing more.  While an important task in an escrow, nothing beats coming up to speed on property values yourself by monitoring the market and visiting houses yourself in your small slice of the market.