If you thought finding the perfect home was the hard part of the home buying process, what until you actually have to go from offer acceptance to closing.
A bunch of steps need to be taken in proper succession order to take you through escrow, one of which is a home appraisal.
What Exactly is an Appraisal, and What’s it’s Purpose?
When you finance a home purchase, your lender is going to want to know exactly how much the property is worth under current market conditions to make sure you’re not over-paying for it. Lenders won’t provide loan amounts that are greater than what the home is really worth – doing so will just put them at risk.
Since the home basically acts as collateral for the mortgage, your lender will want to ensure that you’re not over-borrowing for it. If you wind up defaulting on the mortgage at some point and go into foreclosure, the lender will have to turn around and sell the home in order to recoup the money loaned.
If the home is worth less than what the market dictates, the lender will take a loss on the sale. Having an appraisal offers financial protection for the lender when it comes to potentially lending out more than what would be reimbursed.
Who Conducts the Appraisal?
The lender will usually appoint an independent appraiser who has no interest in the property. These professionals are trained and educated in the field of valuating properties, and often are hired through an accredited Appraisal Management Company (AMC). To help make sure that appraisers are as accurate as possible in their reports, standard practices from the Appraisal Standards Board (ASB) are encouraged to be followed.
Qualified appraisers must be licensed or certified and have experience and familiarity with the local area and similar properties to the one being appraised.
It’s usually the buyer who ends up paying for the appraisal, which could run anywhere between $300 to $400. It takes an average of two hours to complete an appraisal. Of course, some properties may be small and simple enough to take less time, while much larger homes with multiple issues could take a lot longer to be fully appraised.
How Do Appraisers Determine the Value of a Property?
A lot goes into appraising a property, including physically inspecting the home and the lot it sits on, as well as the surrounding neighborhood.
Physical Inspection – Appraisers will check out every amenity in the home, including the number of bedrooms and bathrooms, square footage, lot size, floor plan, number of levels, and so on. If any issues are discovered that negatively affect the value of the home, they’ll be duly noted on the report.
The actual physical inspection itself is a critical component of an appraisal report. Measurements are taken, photos are snapped, and notes are jotted down. Any recent additions or improvements are recorded, as are any issues that need repair.
If there are any other structures on the lot, the appraiser will have an in-depth look at those too, including garages and sheds.
To keep things consistent, appraisers typically use a standard Fannie Mae-approved Uniform Residential Appraisal Report for single-family homes. This report template requires a thorough description of the interior and exterior of the home, the area, and recent comparable sales. Notes, photos, maps and public land records can all be used in the report to generate a value for the property being appraised.
The Research Phase – Much like real estate agents using “comps” to determine an accurate offer price for buyer clients or listing price for seller clients, appraisers also use recent sales of similar properties to come up with an accurate value.
Of course, current market trends also play a key role in the valuation process. For instance, low interest rates might make it much more affordable for buyers to get into the market in that particular area, which can have a direct impact on an increase in demand and a jump in property values.
From the details gathered, the appraiser will then analyze the information and come up with a final value.
What Happens if the Property is Under-Appraised?
We’ve already touched up the reason why lenders shun an appraisal that comes under the purchase price. If your appraisal comes in lower than what you agreed to pay for the place, a few things can happen.
Many times homebuyers simply walk away from their deals, while in other cases, sellers may choose to lower the sale price in order to avoid a dead deal. Sometimes (though not likely nor recommended), buyers will pay the difference between the appraised value and the sales value in cash, then obtain a loan for the remaining amount.
In many cases, buyers will request that their lenders issue a second appraisal from a completely different appraiser. Maybe the initial appraiser made some errors, or wasn’t as qualified or familiar with the neighborhood as he or she should have been. Or perhaps the information that was being used was imperfect or inaccurate.
Buyers and sellers can also provide the appointed appraiser with appropriate information regarding the value of the home, including recent similar property sales that the appraiser might not have previously looked at or considered.
Under-appraisals are more typical when there’s a bidding war on a home, and each competing buyer raises their price higher and higher in order to outbid the others. When the seller finally picks a winner, and it comes time for an appraisal, both parties may quickly discover that the multiple bidding scenario pushed the sales price higher than what the current market value can support.
When it comes to real estate deals, a under-appraisal for a property can provide an opportunity for buyers and sellers to re-negotiate the conditions and clauses in the contract. In fact, buyers sometimes have an advantage in that a low appraisal can serve as some form of ‘proof’ that the home should be sold at a lower price. This in turn can help convince the seller to drop the price so the deal can proceed, at a price point that’s more favorable to the buyer.
The Bottom Line
Appraisals usually come out as the buyer, seller, and lender would hope – either at or above the sales price. This task is just another step in the closing process, and is a necessary part of the equation if mortgage financing is needed. Under-appraisals, however, can throw a wrench in the deal, and can delay or cancel it altogether. Either way, it’s in your best interest to have a basic understanding of why an appraisal is needed, and what goes on throughout this process.