What are Home Appraisals?
Home appraisals are used by lenders during the mortgage application process as an objective way to assess the value of the home. They are an unbiased estimate of how much a home is worth in the current market which allows lenders to ensure that the requested amount of money is appropriate for the true value of the home.
A third-party appraiser will estimate a property’s market value based on recent sales of similar homes (CMAs – comparative market analysis), and the property’s condition and location. Appraisals are not the same thing as a home inspection as they are required by the lender and determine market value, whereas inspections assess potential issues with the property. Both, however, can have a ripple effect on negotiations.
Conventional loan appraisals may differ from an FHA-backed loan or VA loan appraisal in that they do not necessarily need to test utilities or appliances. This Fannie Mae template is an example of a typical appraisal report.
The Appraisal Report
Appraisal reports essentially contain the value, which is usually good for about four months, defined characteristics and features, and comparative market analysis of the property. Most buyers first look at the page that confirms the value and if its in line with the sales price. According to the National Association of Realtors study from June 2020, appraisal issues were 18% of the closing delays and 9% of terminated contracts.
Low Appraisals and Mortgage Applications
Lenders approve loans based on the loan-to-value ratio (LTV) which compares the value of the loan to the value of the property. If your home appraisal is far lower than the accepted offer on a home, then the bank may not be willing to lend money for the selling price and more money may need to be brought to the closing table to make up the difference, or the buyer and seller may need to go back to step one to agree on a lower price. It creates an extremely stressful and time-consuming situation that can be avoided if sellers do their best to increase the home appraisal value before it’s estimated.
Right now, many homes are selling over the initial asking price, so pricing is absolutely key. This means that if sellers can do their best to raise the appraisal value everyone will be in a better position for a smooth closing.
Buyers can have preemptive recourse by including an appraisal contingency clause in the offer that states they can walk away from the deal if the appraisal comes in too low. The appraisal contingency can instead say that the property must appraise at a certain amount or the buyer can back out if it comes in lower. Either of these options saves the buyer from being obligated to come up with the difference at the closing table.
The LTV, in the best interest of the buyer, should be at or below 80% to avoid private mortgage insurance (PMI). For example, if a home is appraised at $400,000 and the accepted offer price is $400,000 and the buyer would need to put $80,000 down (20% of $400,000). LTV is calculated by subtracting the down payment from the selling price and dividing that number by the appraised value.
Selling Price/Appraised Value of $400,000 – $80,000 (the 20% Down Payment) comes to the $320,000 (the loan amount). Take the loan amount and divide that by the appraised value and you get .8 which times 100 is 80% LTV. This instance is favorable- the seller is getting the offer they accepted, the buyer is getting their mortgage and avoiding PMI which is an additional couple hundred dollars a month.
What if the appraisal comes in under the selling price? Say the selling price is $400,000 and the appraised value is $380,000? That $20,000 difference will need to be brought to the closing table by potential renegotiation with the parties unless there was already an appraisal clause in place.
If renegotiation is on the table then it can be worked out with either the buyer increasing their down payment by $20,000, the seller meeting them halfway and decreasing the selling price by $10,000 and the buyer increasing their down payment by $10,000, or the seller decreasing their sell price by the entire amount. If the appraised value comes in over the selling price or at the selling price, no further action needs to be taken on either party’s part.
How to Help Ensure the Property Appraises High as Possible
There are a few things seller’s agents can do to ensure the appraiser has all the information necessary to factor in for a potentially higher appraisal value:
- Meet the appraiser with comparable properties when possible
- If the appraiser is doing a drive-by only due to social distancing restrictions, offer to walk them through the inside on Zoom
- If they are doing a drive-by and won’t let you Zoom, make sure they have updated pictures, especially of upgrades
- If you have more pics than on MLS or high-ticket items not mentioned in the blurb or MLS pics make sure the appraiser knows
In this extremely competitive market, with historically low inventory, buyers have been resolved to make very high offers in order to beat out any other bids. This is a result of the COVID outbreak which caused a major slow down in the number of homes being listed this year. This also happens in typical open market situations when it’s a seller’s market, but not on the scale that we are seeing in the early fall of 2020.
Buyers and sellers both need to be savvy in this situation, as most deals hinge on the buyer obtaining a mortgage unless it’s a cash offer. Buyers need to be aware that overbidding may result in the appraisal not coming in at the offer price and thus need to decide if they’re ok making up that difference at the closing table. Sellers need to be aware that accepting a very high offer may result in the buyers not being able to obtain the mortgage and may have to consider either negotiating a lower sell price or going back to the drawing board to find another buyer. In any case, buyers and sellers need to work together in this climate to get what they want: a seat at the closing table.