What is a home appraisal? And why is it so important?
- An appraisal ensures that the banks feel comfortable they can liquidate the property for what is owed if you default on a loan.
- Most mortgage programs require home appraisals
- Appraisals may identify other problems with the property, such as zoning issues
- Professional appraisers inspect the home and land and compare it to recent sales of similar properties nearby. We refer to these as “comps”.
- They judge how much the differences (plot, location, upgrades/amenities, square footage …) between those properties and “your” property are worth. Ultimately, appraisers come up with a fair market value for the property.
- Common Question: My property appraised for less than its purchase price (what now?)
You would be required to cover the difference on top of your down payment. Example $100k purchase price
- Banks will borrow up to 80% of the value of a property.
- $20k down in cash or equity to cover the other 20%
- Appraisal comes back at $95k
- Bank will lend 80% of $95k
- You would need to $19k in cash or equity to fulfill their down payment
- You would then have to produce the additional $5k in cash or equity to cover the difference from the appraisal.
- Of course, lenders don’t end up paying for their appraisals. More often, it’s the home buyer. However, in some situations, the seller traditionally picks up the tab.
This cost means many purchasers see appraisals as undesirable. At best, they’re yet another charge on the long list that makes up closing costs. At worst, a low appraisal can torpedo a deal, snatching a dream home from a keen buyer. They can sometimes provide an "out" if the offer is far over asking.
People buying a home with their own cash aren’t obliged to have an appraisal.
Those who are experts, notably professional developers, rarely bother. They reckon they know as much as any appraiser. And, anyway, what’s the point of establishing the market value of a home if you’re going to tear it down and build a new one? You just need to know the going rate for development land.
When borrowers don’t need an appraisal
Mainstream mortgage lenders will always require an appraisal when you’re buying a home. But they sometimes won’t insist on one when you’re refinancing.
Related: What is a mortgage refinance, in plain English
The choice is with the lender. However, the general rule is that appraisals aren’t always needed when the total amount of the loan when refinanced is $250,000 or less.
Lenders are least likely to require an appraisal when you want a “rate-and-term” refinance. That means you pay your closing costs out of pocket and improving on your mortgage terms without increasing the balance. if you wrap the refinance costs into a new loan, it’s called a “limited cash-out” home loan.
Lenders are most likely to require an appraisal when your loan-to-value exceeds 80 percent or when you apply for a cash-out refinance. They are least likely to require one when you have a lot of equity or do a streamlined refinance, which means refinancing with the same program and mortgage insurance.
What you get and what it costs
Typically, a home appraisal report includes:
- Explanation of the valuation — Like math students, good appraisers show their work
- A brief overview of the local market’s trends — Are prices currently going up or down? If so, how quickly?
- Summary of the home’s characteristics — Its condition, size and any improvements that have been carried out
- Other considerations — Has anything else about the home or its neighborhood affected the valuation?
- Structural problems and defects — Any issues that the appraiser noticed that affected her valuation
It’s important to recognize that home appraisers are not home inspectors. Don’t rely on their expertise to uncover structural problems because they won’t always have any. And, in any event, it’s not their job to look for them.
Appraisers typically value your property in several ways: the most-common “comparables” valuation, as detailed above, finds a value by comparing the subject property to other nearby sales. The “replacement cost” is what it would take to replace the home on that lot. And the “rental schedule” arrives at the value by considering rental income.
Can you influence the outcome?
Before the financial crash of 2007-08, many appraisers felt pressure to inflate their valuations. Subsequent state and federal legislation sought to put an end to that. Many property professionals misinterpreted the 2010 federal law and now believe they’re not allowed to interact with appraisers. That’s not true.
Writing for Huffington Post, The Appraisal Foundation President David S. Bunton says the legislation contains exclusions “that specifically allow for communication with the appraiser.
For example, the laws specifically permit a party to the transaction requesting an appraiser to correct errors in an appraisal report and to provide additional clarification or explanation for information in an appraisal report.
“In addition, these laws allow a party to the transaction to request that an appraiser consider additional information about the property, including additional comparable sales information.”