An “appraisal” is a comprehensive report that determines the value of your property based on a number of valuation factors, ranging from gross living space, to the view and the year a property was built.
If you plan on purchasing a new home or refinancing your current loan, you will most likely need to order an appraisal. Typically, a bank or mortgage broker will handle this for you, but you will still have to foot the bill unless it’s built into your mortgage rate.
Appraisals typically cost anywhere from $250 to $500. The cost will vary based on property type, location, and square footage. Multi-unit properties and properties in rural areas will usually cost more to be appraised than a single-family residence in a densely populated area.
The most common type of appraisal is the Uniform Residential Appraisal Report, or URAR. It consists of interior and exterior photos, comparison sales (comps), and a complete cost breakdown of the property. This type of appraisal is a blend of both a market and cost approach.
How Is My Home Appraised?
The cost approach establishes value by determining what the cost would be to rebuild the structure from the ground up. The value approach determines value using comparison sales in the immediate area that have sold within a recent period of time.
The comparison sales are broken down in the appraisal report as well, and compared to the subject property. Each comparison sale is given or deducted value in a number of categories based on how it stacks up against the subject property. The net value of the comparison sales are then averaged to come up with a median appraised value for the subject property.
The value of the subject property is really the most important factor when it comes to securing financing. Banks and mortgage lenders need to ensure your property is in good condition, and truly worth what you or your broker say it’s worth. Any possible valuation inconsistencies will likely cause investors to shy away from purchasing the mortgage, leaving the bank or lender with a vacant property and a major loss if the property declines in value. Even Donald Trump could buy a shack and fail to obtain a mortgage because the property itself simply isn’t marketable.
The Appraisal Review
Once an appraisal is ordered, most banks and lenders will order a review of the appraisal. The review will be conducted by another appraiser or simply by the use of an AVM, or Automated Valuation Model. This is where many borrowers get into trouble. If the review comes in low, or if the property is deemed incomplete, hazardous, or unique in any way, a bank may decline the loan and deny financing to the potential borrower. Even if the borrower has outstanding credit and assets galore, a faulty, unique, or overvalued property can kill the deal.
That’s why it’s always important to use a qualified appraiser who assigns a realistic value to your home so there aren’t any surprises when it’s do-or-die time. It’s better to know the true value of your home upfront before you sign any contingencies or purchase contracts. And remember that the quality of your appraisal will determine the quality of your review (unless it’s automated).
The review appraiser will always find the value based on what’s given to them. If they receive a poor appraisal report, they will likely assign a poor value. I’ve seen brokers submit multiple appraisals and receive completely different values based solely on the original appraisal itself.
Come January 26th, 2015, Fannie Mae will let lenders use a proprietary tool called “Collateral Underwriter,” which provides an automated appraisal risk assessment complete with a risk score, risk flags (potential overvaluation), and messages to the submitting lender that warrant further review.
CU works by leveraging an extensive database of property records, market data, and analytical models to analyze appraisals for quality control and risk management purposes.
In the future, lenders may be granted waiver of representations and warranties on value so they can lend more freely, at least when it comes to questionable property values.
What If the Appraisal Is Lower Than the Purchase Price?
One issue that happens pretty frequently is the appraised value coming in lower than the agreed upon purchase price.
For example, if you agree to buy a home for $200,000, and apply for a loan with 20% down, you’d need a loan of $160,000 and a $40,000 down payment. That equates to a loan-to-value ratio of 80%, which is simply $160k divided by $200k.
Now imagine the lender comes back and tells you that the property only appraised for $190,000. Your $160,000 loan amount based on the $190,000 value would push the LTV to ~84%. And yes, lenders use the lower of the sales price or the current appraised value. They don’t care what you’re willing to pay for it.
This is a problem because your loan would now require private mortgage insurance, and that’s if the lender can even offer you a loan above 80% LTV.
The solution would be to either ask for a review of the appraisal, renegotiate the purchase price (lower) with the seller, or put more money down, assuming you have extra cash on hand. Of course, you might wonder if you’re overpaying for the property if it doesn’t come in “at value.”
Using our same example, if you decided to move forward with the full purchase price and wanted to keep your loan at 80% LTV, you’d only be able to get a $152,000 loan. That means you’d need to come up with $48,000 for the down payment, as opposed to the original $40,000.
Although an appraisal is irreplaceable, you can do some quick research on your own by using a free internet house values tool that generates a quasi-property appraisal in a matter of seconds by simply typing in the home address.
Read more: How accurate is a Zestimate?