A few years back, home prices were on the decline, big time. The bubble had finally burst and the housing crisis was in full swing.
To put it mildly, prices just moved too high too quickly, and had to fall back down to earth.
Meanwhile, distressed sales, such as foreclosures and short sales, put even more downward pressure on prices.
All in all, this made it difficult for appraisers to please their borrowers. And by please, I mean manage to get properties to come in at value so they could be financed.
Fast forward to today, and home prices are shooting higher and higher every month, so much so that there are talks of another bubble. Or at least a bubble within a bust…whatever the heck that means.
In California, home prices increased 8.3% in March from February, and were up a staggering 24.7% from a year earlier, per the latest report from DataQuick.
This is pushing many homeowners above water, thereby eliminating the need for a short sale, and also allowing others to tap into their home equity. Even the cash-out refinance is back. Hooray!
While this is all great news for existing homeowners, the quick increase in prices may present new issues to appraisers and prospective buyers.
Homes Selling Above Value
These days, one could reasonably argue that some (most?) properties are selling above their fair market value.
After all, many headlines nowadays focus on “bidding wars” and a lack of inventory, which has surely led to higher prices.
But is it getting out of hand? Are today’s buyers overpaying for the homes they so desperately think they need to buy right this instant?
Assuming they are, appraisers may be under even more pressure to “find that right value,” even if it’s stretching things a whole lot.
This is especially tricky today because appraisal standards have tightened since the crisis, just like lending standards.
Additionally, comparable sales include foreclosures and short sales, many of which took months to close.
For example, a short sale could have been in contract for close to a year before selling and being included as a recent comp.
As a result, the property may not appraise for the hefty final price agreed upon after 20 offers came streaming through the door.
Why Cash Investors Win
Now this may not be an issue for those paying with cash, seeing that they’re willing to forego appraisal and loan contingencies.
They also seem prepared to throw competitive offers at sellers, even when paying with all cash.
This makes it extremely difficult to compete if you can’t pay for a property out of your own pocket.
To play, you’ll either need to come up with a sizable down payment and higher offer, or waive contingencies.
In all those instances, there is a decent amount of risk. You’re essentially banking on appreciation down the road, and accepting to pay a higher price than the bank/lender values the property.
But for those who need to finance the property, there’s not much way around it. Just be sure to cover all your bases.
Dealing with a Low Appraisal
If the appraisal happens to come in lower than the purchase price, the bank will only lend based on the appraised value.
As noted earlier, this is how they “value” the property. They don’t care that you are willing to pay more.
For example, if the agreed upon sales price is $400,000, and the property appraises for $375,000, your loan will be based on the lower amount.
If you want to stay at say 80% loan-to-value (LTV), the loan amount would need to drop to $300,000, as opposed to $320,000.
This means your down payment would rise from $80,000 to $100,000, which could put the deal in jeopardy if you don’t have the cash.
If you’re putting a lot more down, say 30-40%, it may be easier to change the loan terms without coming out of pocket, though your mortgage rate may rise.
Of course, you may be able to renegotiate the purchase price if the appraised value comes in low, but the seller must be willing to budge.
These days, there’s a good chance they won’t want to lower their sales price, even if the property doesn’t appraise.
So if you are competing with all-cash buyers, showing the seller you have extra funds in the case of a low appraisal may be helpful.
Unfortunately, you may not even get a chance to take a crack at it if the seller doesn’t believe your high offer will come close to appraising.
They may just want to take a slightly lower cash offer and avoid any unwelcome surprises.
In other words, it’s a bad time to buy a house in many areas of the country, as I mentioned a week or so ago. Bad because EVERYONE wants to buy at the same time.
A good time to buy a house is when no one else is.