After months of searching, you’ve finally found the perfect home and are already picturing your family relaxing in the den. The last thing you want is a problem during the loan process that derails your dream. Understanding the home-buying process is critical to making things go smoothly. One item you need to know is the home appraisal process, which is conducted by a licensed appraiser. What is a home appraisal, and how can it affect your home loan? Let’s dive in.
What is an appraisal?
When purchasing a home and applying for a mortgage, one of the first steps the lender will do is order an appraisal. The house will need to be evaluated by an independent, unbiased professional appraiser to estimate the home’s fair market value. A home appraisal is an expert’s opinion of the value of a given property. This is different from an inspection, which evaluates the condition of the property and looks for things like structural problems, fire and safety hazards, roof conditions, mold, and other issues.
How is an appraisal based?
The fair market value of a home is based on its general condition, age, location, size and current market trends. The number of bedrooms and bathrooms, plus any structural improvements, like remodeled rooms or additions, are critical factors.
Amenities are another consideration—is there a swimming pool on the property or a boat dock? Features such as hardwood floors or majestic views also influence value.
The purchase price of comparable sales within a given radius is a crucial component. These prices demonstrate what the market is willing to pay for a home similar to the one being appraised and help ensure an accurate appraisal.
What happens during an appraisal?
Because the home will be used as collateral for the mortgage loan, the lender needs to be assured that the money loaned doesn’t exceed the home’s value should the buyer default. Unfortunately, you don’t get to choose your home appraiser. The lender orders the appraisal, and the appraisal cost is paid by the buyer (generally between $300-$400). This is usually how the home appraisal process works:
- Step 1: The appraiser will conduct an in-person inspection of the home and visually inspect the interior and exterior.
- Step 2: The appraiser will then take measurements and note any conditions that might positively or negatively affect the property value before compiling the home appraisal report.
- Step 3: The appraiser will research recent home sales in the areas and deliver a final appraisal report that includes an estimated value.
What if the appraisal is lower than the sale price?
If the appraisal value is lower than the sale price, you’ve reached a fork in the road. The mortgage lender won’t approve a loan for more money than the home’s worth. But don’t worry—these things happen, and you have a few options if you encounter a low appraisal.
Negotiate the home price
You can use a low appraisal as a negotiating tool to encourage the seller to lower the home’s price. You can ask the seller to match the appraised value or meet in the middle. Your realtor can help you determine the terms. Some concessions might include a rent-back agreement, covering any home improvements yourself, or even taking large furniture (e.g., a pool table) so the seller doesn’t have to worry about moving those items.
Make a larger down payment
If you have enough savings, you can choose to make a larger down payment. When you make a larger down payment, it helps mitigate the low appraisal by reducing the loan amount needed—which means the lender is taking on less risk. This can also help you negotiate the home’s price and potentially reduce your closing costs.
Challenge the appraisal
If you think the appraiser understated the value, you have the option to challenge the estimation or get a second appraisal. You can submit a letter to your lender and ask for a reconsideration of value (ROV). Be sure to include evidence of errors or comparable home sales, as well as updated comparable sales if needed.
Sometimes home values lower due to foreclosures or short sales in the area. You may convince your appraiser that this was the case with some of the comparable properties while at the same time, proving that your home is in significantly better condition than those that were sold at a discount. Upgrades or renovations that were made without a permit can’t be considered in the appraisal.
Walk away from the sale
When you buy a home, you realtor will likely include an appraisal contingency in your contract. This protects you (the buyer) if you receive a low appraisal. If you and the seller can’t come to an agreement, the appraisal contingency allows you to back out of the contract without losing your earnest money deposit.
How can sellers prepare for an appraisal?
As the seller, there are a few easy steps you can take to ensure the appraisal process goes smoothly—and increase the value of your home.
- Review previous appraisals: Look at previous appraisals and see what factors lowered your home’s value. See what factors may have lowered your home’s value in the past.
- Gather important documents: You’ll want a list of any upgrades, evidence of your home’s last sale price, and (if applicable) a land survey that details your property size.
- Spruce up your curb appeal: Do some landscaping, trim the hedges, or clean the gutters to make your home more pleasing.
- Make minor repairs: You don’t need to go all out—this could be as simple as fixing chipped paint or replacing door knobs.
- Know the comps: Check out the comparable sales in your neighborhood so you can gauge what similar homes are selling for.
- Prepare for the visit: Tidy up and crate or contain pets to make the appraiser’s job easier.
What if the appraisal is higher than the sale price?
If the appraisal value is higher than the sale price, this transaction can keep moving along as planned. The expert opinion of the appraiser is that the value of your soon-to-be new home is higher than what you’ve agreed to pay. Congratulations—you already have equity in your new home!
If you’re refinancing, this means you have enough equity in your home to borrow against. Don’t worry though—this won’t increase your property taxes. Your property taxes are based on the assessed value, which is determined by your local tax assessor.
Pros & Cons of a High Appraisal |
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|---|---|
| Pros | Cons |
| You can borrow the money needed to buy the home at the agreed sale price. | The seller could try to renegotiate the price. |
| If you’re refinancing, this can increase your equity or remove private mortgage insurance (PMI). | You run the risk of borrowing more than you can afford if you’re getting a home equity loan or line of credit. |
| If home prices fall in the area, you could owe more on your house than it’s worth (in the case of refinancing). | |
Pros & Cons of a Low Appraisal |
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|---|---|
| Pros | Cons |
| The seller could lower the asking price to match the appraisal. | Your lender might not loan you the funds to buy your new home. |
| You have the option to back out of the sale and get your earnest money back. | You might need to offer more money for a down payment. |
| If you’re refinancing, you don’t have enough equity to borrow against. | |
The value of an appraisal
The appraisal process isn’t meant to put a roadblock between you and your dream home—it’s there to protect you and the lender. You don’t want to unknowingly overpay for a home, especially if you need to sell it in the short term. It could be worth less than you owe, and that’s an unfortunate situation for everyone. From the lender’s perspective, they don’t want to own a house they can’t sell to cover the outstanding loan balance in case of a loan default.
In the home-buying process—or for refinancing homeowners—the appraisal is just one of many things that need to occur to get to the closing table. Regardless of whether your appraisal comes in high or low, understanding the process is your best defense to managing the hurdles until you get to your home sweet home.
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