How Appraisals Affect Home Purchase
What is an appraisal and how does it differ from the initial purchase offer? An appraisal is an estimate of value of a home prepared by a trained and impartial third-party, an appraiser. The buyer, the seller, and real estate agents all have a financial interest in the value of the home and cannot give an impartial estimate of its worth.
The appraisal will value the home based on its size, construction type, features, neighborhood, recent comparable sales in the area, and recent trends in the market. All the factors used to produce an appraisal value will be detailed in a report on the home that discusses each factor and its effect on the overall appraised value of the home.
An appraisal is important to understanding the value of the home compared to the offer, but is also an integral part of the lending process. Lenders will require an appraisal as part of the underwriting for a mortgage loan. If the appraisal comes in below the offer or the buyers asking price, the lender may not approve the loan for the home at that price or may require more money down.
Appraisal Vs. Home Inspection
While the two are similar, an appraisal serves a different purpose than a home inspection. The goal of an appraisal is to determine the market value for a home. A home inspection provides more detail on the condition of the home, including repairs that may need to be made. The home inspection, unlike the appraisal, is not required by the lender, but it does provide value for the buyer because it uncovers possible hidden costs of repairs that may be needed. Based on the home inspection, the buyer might want to adjust their offer or ask the seller for a concession.
Who Orders An Appraisal
The appraisal is the buyer's responsibility, but it is ordered through the lender. Typically, the appraisal fee is paid to the lender who then utilizes one of their approved appraisers or appraisal companies. The appraisal and the payment for the appraisal take place before any financing can be written because the appraisal is the basis of important underwriting considerations such as the loan-to-value ratio.
If the appraisal value comes in higher than the offer, this has no effect on the financing. The purpose of the appraisal from the lender's perspective is to ensure that the lender isn’t lending more than the home is worth or violating any underwriting guidelines in regard to loan-to-value ratio.
If the appraisal comes in lower than the offer, the lender may not finance the home at the offer or asking price. A mortgage loan is secured by the property, and if the property is worth less than offered, the lender may not be able to proceed with the loan without more money down or a reduction in price.
There are a number of reasons that an appraisal may come in lower than the offer amount, including some market conditions. A competitive market can generate multiple bids for a property, driving the price above the appraised value. An appraisal value might also come in low because of foreclosures in the neighborhood or an overall trend in pricing for the local market.
A low appraisal doesn't mean that the loan won’t go through. It will affect the loan-to-value ratio though, and to move ahead with the loan, someone will have to make up the shortfall. You can cancel the transaction based on the low appraisal, but there are other options you can explore first.
You can put more money down. This will lower the loan-to-value ratio and may get the loan approved. However, if you proceed in this direction, you are purchasing a home above its market value. The home might appreciate in value over time to cover your increased investment, but markets don’t always go straight up and a considerable amount of time might be required for the value of the home to match the purchase price.
The seller can lower the asking price. Faced with an appraisal below the asking price, the seller may be willing to lower the asking price for the home. Any other buyers who require a mortgage will also need an appraisal for lending approval. The appraisal for those buyers might come in low as well. A low appraisal introduces risk for the seller which may be enough incentive for the seller to reduce the price.
A second appraisal can be ordered, paid for by the seller or the buyer. It is possible that a second appraisal will value the home higher than the first, but it will cost someone some money to find out, and there are no guarantees.
In some cases, the seller can offer to carry a second mortgage for the difference. This provides the cash needed to make up the difference, but creates an additional loan for the property, which may not be a desirable solution.
Most commonly, a low appraisal becomes an opportunity to negotiate toward the appraised value or a reason to look at other homes that might meet your needs if an acceptable price can’t be reached.