After you give a lender your Intent to Proceed, it’s time to order your home appraisal.This is a critical (and potentially frustrating) step in the home buying process. Let’s break it down.
What is a home appraisal?
An appraisal is an assessment of how much the home is worth. These assessments are done by a licensed professional. You pay them a fee and they inspect the property. The appraisal is done by a neutral third party with no affiliation to the seller, the lender, or the buyer.
Appraisers look at the neighborhood, nearby home values, and the condition of the property. The appraiser usually has the title report. This is a description of the home and how it has changed over time. As owners make improvements to their home, they pull permits. Those changes will be reflected on the title report.
The appraiser will inspect high and low. They will check the foundation, walls, roof, plumbing, electrical, windows, doors, and more.
It is fairly common for an appraiser to find issues, especially in older homes. Some common issues:
- Cracks in walls, ceiling, or foundation
- Water leaks or suspicious moisture
- An old roof – If the roof looks like it will need replacing within the next few years, the appraiser will make note.
- Lead paint – If the home was built prior to 1978 there’s a good chance there is lead paint somewhere.
- Un-permitted addition – This is really common in some areas. If major changes were made and permits were not pulled, this can be a red flag. The home won’t match the title report, which means the changes were never filed with the city or inspected. You can learn more about unpermitted work here.
Pro-tip: Unpermitted work can be a major pain point. Your appraiser generally won’t report work done without a permit. You’re not in the clear just because your home passes the appraisal or your loan closes. If a neighbor reports the unpermitted work to the local authorities, you could be in for an expensive headache.
Home appraisal value
There are a few different appraisal methods. For residential real estate, the appraiser will probably use the sales comparison approach and pull comparable home sales in the area.
After the appraiser does their inspection, they’ll make a list of all the issues they found. They’ll also make a list of any bonuses (new roof, updated plumbing, solar panels, backyard pool, etc.). They will make adjustments to the comps based on their inspection. This is the home’s fair market value.
How does the appraisal affect my loan?
The appraiser’s estimated value is a big deal for a few reasons. If your offer price is lower than the appraised home value, you’re set. You negotiated a good deal. However, if your offer price is higher than the appraised home value, this can create issues. First and foremost, you may feel like you overpaid for the home. Obviously this is not a great feeling. Don’t play this game with yourself—the seller may not have sold to you at the lower price. If you felt good about your offer and you can afford the mortgage payment, the home is worth only what someone was willing to pay for it.
However, lenders do not see it this way. They base their LTV ratio on the lower of the appraised value and your offer price. So if the appraisal comes in lower than your offer price, there is a decision to be made.
Dealing with a low appraisal
Let’s consider a scenario: Say you offered $250,000 to buy a house. You are putting $50,000 down (20% down payment) and were getting a loan for $200,000 (80% LTV). Now say the appraisal estimates the home value at $240,000, or $10,000 lower than your offer price. You will have a few options to address the issue.
Get a second appraisal
This is the path of least resistance. Your loan officer and realtor can advise you here. Sometimes appraisers rush through the process or pull comps that were old or not as relevant as other available comps. But beware: the second appraisal could also come in lower than the first, and then you’re in a real pickle.
Renegotiate the purchase price
This can be rough. If you have an appraisal contingency in your purchase contract, you have some leverage. If the seller doesn’t work with you to renegotiate the price, they have to re-list their home. This delay in selling might be a serious wrinkle for them, especially if they’re buying another house at the same time.
If you don’t have an appraisal contingency in your contract, you’re in a tight spot. The seller doesn’t have to renegotiate with you, and if you can’t complete the home purchase, you’ll lose your earnest money deposit.
This is one of those areas where having an experienced real estate agent crafting your offer can save you. If your realtor negotiated an appraisal contingency you have some room to work in this situation.
Put more cash down to keep the same loan
If that appraisal says the home is worth $240,000, suddenly your $200,000 loan is 83% of the home value. To get your loan back to that 80% LTV mark, you’ll have to reduce your loan amount to $192,000 — an $8,000 difference. Your monthly payment will actually go down in this scenario, but you will have to come up with that $8,000 in cash to close the loan.
Adjust your loan
If you don’t have the cash to make up the difference, you may have to adjust your loan. Even though your loan amount hasn’t changed, the increase in your LTV ratio could lead to a higher interest rate, a higher monthly payment, and more cash to close.
This is especially true if you have to pay for mortgage insurance now. The other unfortunate part is lenders see this new scenario as a different loan — you will even get a new Loan Estimate. If you already locked your rate, it might not be applicable anymore. If interest rates went up since you locked, you get burned here.
Likely the most painful decision, but sometimes the right one. Maybe you can’t hustle up the extra cash to close, or you can’t afford your new, higher monthly payment. Or maybe you can afford both of these things, but you decide it’s just not the right financial decision. In this case, it just wasn’t meant to be. Chalk this up as a learning experience and hope you can get your earnest money back.
Avoiding issues with your home appraisal
As you can see, getting the home appraised at the right value is a big deal. The worst part about it is getting the appraisal is not a quick process. Once the appraisal is ordered, you could be in for a week or more of waiting. Here are three ways you can reduce stress during the appraisal process:
If you have more questions about the appraisal process, chat with one of our licensed Loan Specialists. If you’re ready to get pre-approved, you can see your rates in about 3 minutes completely online.