What's an Appraisal and Why Do You Need One?
What’s an appraisal and why do you need one?
If you’re planning to buy house and you’re not a cash buyer then you need a loan to secure the deal. When getting a loan to buy a house your lender or the bank, whoever you’re getting the loan from, will require an appraisal of the property.
What’s an appraisal?
In short, a real estate appraisal is the process of developing an unbiased, professional opinion of value from a licensed appraiser. A licensed appraiser is a third party person who is not affiliated with the sale, they are hired as an outside source to give their opinion of value.
How does an appraiser come up with value?
There are many methods used for determining a homes value but the most common are the home’s amenities, size, location, upgrades etc…and of course the current comparable homes (also known as comps) for that specific area or neighborhood.
Why do I need an appraisal?
You need an appraisal to satisfy the lender’s requirements. The lender wants to make sure that the home is worth what your purchase price is at.
For example, if the asking price is $400,000 and you wrote an offer to the seller at that price the lender wants to make sure it’s worth it. Think about it this way, if you default on your loan or suddenly can’t make the payments and you have to walk away from the property then the lender or bank is now responsible for selling the property and covering all the costs associated with the sale. If you overpaid for a house, (say you bought the house for 400k in a predominately 300k neighborhood) and then defaulted on your loan and had to walk away the lender is now underwater, meaning the home’s loan is higher than the market value. So basically they’re screwed and an appraisal is what helps protect the lender AND you from over paying on a property.
What happens if the appraisal comes in lower or higher than the Purchase price?
Once you get the appraisal report back it will either be higher, lower or at value (at value meaning, right on the money.) So here is a breakdown of what this all means. Again, let’s assume that your purchase price is $400,000.
At Value: If the appraisal report comes back and it appraised for $400,000 then that’s great, that means you’re paying exactly what’s expected in that market.
Higher Value: Now let’s assume the report comes back and it appraised at $410,000, well that’s even better! That means you’re walking in with a little bit of equity already, $10,000 worth to be exact.
Lower Value: Okay here’s the one that nobody wants to hear during an escrow. Let’s assume the appraised value comes back and it appraises at $390,000, what does this mean? Well to be frank it means that according to an appraiser you’re overpaying by $10,000. So now what? **Well, the lender is ONLY going to loan on the $390,000 value so the rest is up to you, with that said you have a few options. The three most common options are:
Ask for a purchase price reduction: You can ask the seller to reduce the purchase price down to the appraised value, in this case it would be $390,000. Most sellers are reasonable and they want to get the sale done so the likelihood of this happening is pretty high, unless the house was really competitive in the first place, then they may not be so quick to drop the price down for you, especially if they have back-up offers. In a perfect scenario they will drop the price or at least meet you half way.
Pay the cash difference yourself: I want to remind you one more time, the lender is only going to loan on the **appraised value or lower. If the seller is unwilling to renegotiate the price then you are now responsible for coming up with the difference in cash between the appraised value of 390k and the purchase price of 400k, so in this scenario there’s a $10,000 difference. So how do you get that money? One way to do it is to take a portion of what you were going to use for your down payment and put it toward the difference in value. Now that scenario is completely up to the lender to decide if you’re even qualified to do that because it would require a restructuring of your loan and it now changes your monthly payment. This one can be tricky unless you have a decent down payment to work with in the first place, then there’s more wiggle room to get creative. If you’re unable to restructure the loan then you simply have to come in with your own additional cash to cover the difference, how you get that is up to you and then lender to decide. Either it’s going to come from more of your savings or maybe gift funds from a family member.
Drop out of the deal: Your third option is to simply drop out of the deal. I know, this is the least favorable option out of the three but at least you still have your appraisal contingency in tact! And yes, your agent is there to make sure you still have your appraisal contingency during the appraisal negotiation period. This is what an appraisal contingency is for, it protects your earnest money deposit (EMD) in case there are any issues with the appraisal. In a scenario where a buyer and seller are unable to come to an agreement over a low appraisal, you can drop out of the deal and still get your deposit back. Unfortunately you are out any cost incurred for the appraisal and any inspections you had done on the property but that’s a very small price to pay in comparison to your EMD which is usually at least 1% of the purchase price, so $4,000 in this particular scenario.
What’s the house really worth?
So to summarize all of this, a property is really only worth what a buyer is willing to pay for it. At the end of the day it’s not the seller, agents or appraisers who set the true market value, it’s the consumer. Yes, you the consumer are the ones who are solely responsible for setting market value, everyone has different needs when it comes to house hunting. It’s you and you alone who has to ask yourself the question, what’s this house really worth to me?
Thanks for reading,
Sara Muir
**Remember this, a lender is only going to loan on the appraised value if it’s at value or lower, they will not loan on a higher amount. Meaning, if your house appraises for higher then that’s great but it doesn’t really mean or change anything. You are not obligated to buy it for a higher price even if it appraises for a higher amount because you are already in contract at a certain price that both the buyer and seller agreed upon. The appraisal is there to satisfy the lender so the seller should not try to use a high appraisal to justify a higher price.