Ask Christy – What is an Appraisal?

This months great question comes from Genny from Queen Anne:

“Since our loan will only cover XX% of the appraised value, how do we know in advance that our offer will not be greater than that amount? Just to clarify, if we made an offer for more than it was appraised for, we’d have to cover the difference out of pocket, correct? I guess we’d just like to know that the house we bid on is selling for close to what it appraises for.”

What is an appraisal?

An appraisal is the process that banks use to determine current market value of a home.  The bank will hire an appraiser to go out to the subject property and give his or her professional opinion of the current value of the home.  Appraisers are extensively trained in property valuation.  The use many factors, such as recently sold comparable properties in the area, condition of home, cost of full replacement and so on.  For more details on what it takes to become an appraiser, the methods that appraisers use and what the actual job of being an appraiser looks like, visit the Appraisal Institute website.   Appraisals typically cost $500 to $550 and are paid for by the borrower.

Why is an appraisal required?

Banks want to make sure that the home is currently worth what you are paying for it.  So let’s say that you are buying a $500,000 home, and putting down 20%.  The bank will only loan you 80% of the appraised value (or $400,000).  The lenders do this to protect themselves in case you for some reason default on your loan or are unknowingly (or knowingly) buying a home for far more than it’s current market value.

What happens if the appraised value is less than I am offering to pay for the home?

In this crazy, fast paced market where homes are selling for 107% of list price and in a very short amount of time on the market, this is a very valid concern.  Although appraisers are aware of this increasingly hot market, sometimes the appraised value isn’t in alignment with the offer price.   If the home appraises for less than the buyer has offered to pay for the property, the buyer must give the seller a copy of the appraisal and then one of these 5 things will happen:

  1. The seller can have the bank re-order a new appraisal at the sellers expense.
  2. The seller can lower the purchase price to the appraised value.
  3. The buyer can agree to come up with additional down payment money to ensure the bank is still only paying X% of the appraised value.  Using our example from above, if you were buying a $500,000 house with 20% down, the bank would be willing to lend you $400,000.  If the appraised value came back at $475,000, the bank would only be willing to lend you  $380,000.  So if you decided to make up the difference in the down-payment, you would have to come up with a $120,000 down-payment instead of the original $100,000 down payment.
  4. The buyer and seller can meet somewhere in the middle.  Maybe the seller will agree to lower the purchase price to $485,000 and the buyer will increase the down-payment amount by $15,000.
  5. If the seller does not reduce the price, or order a new appraisal that comes in at the offer price, the buyer can walk away from the purchase and get a full earnest money refund.
How do we know if the home we are buying will appraise for the amount we are offering?

The tough and honest answer is, we don’t.  Homes are almost always getting multiple offers and selling for a bit over what all logic tells us the home is worth.  The good side of that is that every single home I have sold this year and last year has come in at or above appraised value.  The best thing you can do is to decide the maximum price the home is worth to you before you put in the offer.  I am always happy to provide information on comparable sales in the area to help us see if we are in the ballpark of the potential appraised value.  And, in the worst case scenario, you can always get out of the purchase with a full earnest money refund if the appraisal is below value and the seller is not willing to reduce the purchase price.

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