An appraisal helps to establish a property's market value the likely sales price it would bring if offered in an open and competitive real estate market.
An appraisal can be used to estimate a property's value at any time in history. See the following examples.
Current value for a buyer or seller.
At a past time for divorce, estate or tax purposes.
At a future time for investor.
The bank requires an appraisal when you ask to use a home or other real estate as security for a loan, because the lender wants to make sure that the property will sell for at least the amount they are investing in it.
Don't confuse a comparative market analysis, or CMA, with an appraisal. Real estate broker/agents use CMAs to help home sellers determine a realistic asking price. Experienced broker/agents often come very close to an appraisal price with their CMAS, but an appraiser's report is much more detailed--and is the only type of report a bank will use in its lending process.
About Appraisers and Appraisals
What You'll See on an Appraisal Report
Appraisals are very detailed reports, but here are a few things they include:
Residential Appraisal Methods
There are two common appraisal methods used for residential properties:
Sales Comparison Approach
The appraiser estimates a subject property's market value by comparing it to similar properties that have sold in the area. The properties used are called comparables, or comps.
No two properties are exactly alike, so the appraiser must compare the comps to the subject property, making paperwork adjustments to the comps in order to make their features more in-line with the subject property's. The result is a figure that shows what each comp would have sold for if it had the same components as the subject.
The cost approach is most useful for new properties, where the costs to build are known. The appraiser estimates how much it would cost to replace the structure if it were destroyed.
So What Does the Appraisal Mean to You?
Your personal approval is accomplished early in the loan process, but final loan commitment usually hinges on a satisfactory appraisal. The bank wants to be sure its investment is covered in case you default on the loan.
If the property appraises lower than the sales price, the loan might be declined, but that isn't the only hurdle it must pass. Other facts on the appraisal can be a problem, too:
Those are just a few examples of negatives that could stall your purchase. The lender will study the appraisal carefully before determining whether or not the property qualifies to serve as security for your loan.
It Isn't a Home Inspection!
Appraisers make notations about obvious problems they see, but they are not home inspectors. They do not test appliances, look at the roof, check the chimney or do any other typical home inspection tasks. Never count on an appraisal to help you determine if the home is in good condition.
If the Appraisal Reveals Problems
Don't panic if the appraisal comes in low, because there are often steps you can take to make the deal work.
Other problems that are revealed might make you reconsider buying the home, so it could be a plus that the appraiser found them. If you still want the property, try to come up with a solution to the problems, or do some investigating of your own to verify that the appraisal was correct--because everyone occasionally makes mistakes.
Just remember that most problems are correctable if you keep your cool and try to work through them one step at a time.
Don't panic if the appraisal is low
The contract on your home is signed and details are progressing nicely. The buyers felt it was safe to go ahead with inspections, and the results were acceptable. The closing date is on target. Everyone is waiting for the results of the home appraisal results so that a loan commitment letter can be issued. No one is too worried, because the house sold for an appropriate price, and appraisals have a magical way of coming in just where they need to be.
The Phone Call
Everyone gets a phone call. The home appraisal is $8,000 less than the sales price. Buyers, sellers, and agents all panic--is there anything you can do?
Keep Your Cool
One or both parties may have another contract that hinges on a successful completion of this one, and getting bad news can make everyone a basket case, especially when it's close to closing day.
It's easier to work through the problem if you stay calm, so keep your cool and develop a plan, because there are solutions to make the sale move forward.
A cash buyer should have been protected with a contingency clause that states he can back out of the deal if the home doesn't appraise at or above the sales price.
Buyer Pays More Down
The buyer may want the home badly enough to make a larger down payment, but don't assume that will correct the problem. I've been involved in home sales where buyers were prepared to pay additional money down to make a deal work, but lenders would not approve the loans. They did not want to finance a property that the buyer went into with a negative equity, even if the buyer was willing to take the risk.
Seller and Buyer Negotiate
Seller and buyer come to an agreement, both giving a little.
Dispute the Appraisal
Ask the lender for another appraisal. The lender may send out a another home appraiser or ask the original appraiser to reevaluate the property.
Ask your agent to find out which houses were used as comparables. Does the agent agree they were good comps? Most appraisers haven't seen the comps up close and personal the way agents do. The home appraiser might have unknowingly used houses that needed a lot of work. If poor condition is verified, ask the appraiser to investigate the comparables to see if adjustments should have been made.
Does the Contract Include Personal Property?
Home appraisers only put a value on real property, the land and the improvements to the land. If the contract includes furniture and other types of personal property, it won't be a part of the appraisal. Buyers should pay for it separately.
Is the Seller Paying Funds to the Buyer at Closing?
This often works, but it can be killed by a low appraisal. Always talk with the lender about their policies and the proper wording for this type of agreement. Then be prepared to deal with it if the appraisal comes in low.
If the house is truly overpriced, the sales price should come down. Sometimes it takes a low appraisal to convince a seller that his price is out of line.
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