Updated: Jan 29, 2022
Some of my customers don’t know the home appraisal process and why they need a home appraisal. A home appraisal is necessary when you buy a home using a mortgage because the lender requires a home appraisal to make sure that borrowers are not over-borrowing for their property. The home serves as collateral for the mortgage. If the borrower defaults on the mortgage and it goes into foreclosure, the lender will sell the home to recoup the money it lent. The appraisal helps protect the lender from losing money. If the bank lends more money than the property is worth, they may not recover enough money from selling the property to repay the loan. Therefore, the lender always requires an appraisal to ensure that the home being purchased is actually worth the amount of money requested by the borrower.
A home appraisal is also needed when you refinance your existing mortgage. An appraisal assures that the lender is not giving the borrower more money than the home is worth. If you use cash to purchase a property, you may still want an appraisal to verify the property value and make sure that you do not pay more than the property is worth.
You may wonder how an appraiser determines a home’s value. An appraisal is an unbiased professional opinion of the value of a property. A certified appraiser will conduct a physical inspection of the property, compare the property with recent sales of similar properties, making adjustments for differences in the size, condition, and features of each property, and research current market trends to determine the property’s appraised value. Sometimes, two homes with the same square footage in the same neighborhood will have different appraised values because of differences in their floor plans, quality of the materials and other amenities and features.
When does the appraisal need to be completed? Generally, an appraisal is done after the property is under contract and the buyer has completed their inspection and decided to proceed with the transaction. Some contracts will have an appraisal contingency, though it is hard to include such a contingency in the offer in a seller’s market. When the appraised value is lower than the contract price, the contract can be renegotiated or even canceled if you have an appraisal contingency in the contract. The cost of the appraisal varies depending upon the condition, size, and location of your property and what type of appraisal you need. The cost for a typical home appraisal can range from $200 to $500. The cost of the appraisal is paid for by the buyer.
Many times, the lender will order the appraisal because the appraisal is critical to the lender’s decision to approve the loan. Many lenders have their own list of recommended appraisers, chosen for their track records as reliable, high-integrity professionals. However, the certified professional appraisal is an independent contractor who is licensed by the appraisal institute. By federal regulations, the appraiser must be impartial and have no direct or indirect interest in the transaction.
A property’s appraised value is determined by comparing the recent sales of similar properties and current market trends. The home features, such as number of bedrooms and bathrooms, floor plan functionality, and square footage are also the main factors to assess the home value. The home appraiser will physically inspect the property and carefully exam the interior and exterior and note conditions that affect the property’s value. The appraisal report form is the Uniform Residential Appraisal Report from Fannie Mae for single-family homes. The report describes the interior and exterior of the property, the subdivision, and nearby comparable sales. It also includes the appraiser’s analysis and conclusions of the property’s value based on the appraiser’s observations.
A Uniformed Residential Appraisal Report contains these elements:
1. A street map showing the appraised property and the comparable sales properties used.
2. Exterior building sketches or pictures
3. An explanation of how the square footage was calculated.
4. Photographs of the home’s front, back, and street scene
5. Front exterior photographs of each comparable property used.
6. Market sales data, public land records, and tax records that the appraiser used to determine the property’s fair market value.
7. Other miscellaneous information.
If the appraised value is lower than your contract price, you can negotiate with the seller to reduce the purchase price to match your appraised value. Generally, the lender will not lend you more than their approved percentage of the purchase price or the appraised value, whichever is less. For example, if a lender has agreed to finance 80% of the purchase price and the appraised value is less than the purchase price, the lender may still agree to finance 80% of the appraised value and the buyer will need a larger down payment. As a seller, you should know that the buyer may not get a loan to cover the portion of the purchase price that exceeds the appraised value. That means the deal may fall apart if you don’t reduce the price to match the appraised value. Generally, the difference in appraised value that would be calculated by two appraisers on the same property is quite small. If your appraisal is less than your purchase price, you may want to get a second appraisal if you think your home is worth more than the value from the first appraisal. During recession years, low sales prices for distressed properties in poor condition could reduce the value of a similar property that is in a great condition. Because the appraiser is required to use the most recent sales of similar properties in comparable neighborhoods in their market comparison, low prices on those homes may result in a lower appraised value. In that circumstance, you may want to wait until the market recovers before you sell your property.
If you are refinancing a conventional mortgage, a low appraisal value will be a disadvantage. The home’s appraised value needs to be above the value required for the amount of loan that you want to refinance, otherwise your loan will not be approved. However, if your existing mortgage is an FHA mortgage, you can refinance without an appraisal through the FHA streamline program, which is a great advantage for underwater homeowners.
If you are a cash buyer, a low appraisal value will give you the opportunity to renegotiate the contract price to match the appraised value. The seller may be reluctant to reduce the price, however, and you always have the option to cancel the transaction if you have an appraisal contingency in your contract.
For Federally related transactions, according to Uniform Standards of Professional Appraisal Practice (USPAP), the appraiser is required to review the fully executed contract, including addendums and signature pages and conduct an appraisal for lending purpose. The appraiser will verify the fully executed sales contract, date, and identify the buyer and seller, the contract price, the type of financing and amount of the seller’s and buyer’s contributions toward the closing costs, etc. The appraisal report must include all this information and conform with the sales contract. Most bank mortgages are sold to Fannie Mae and Freddie Mac in the secondary market. Fannie Mae and Freddie Mac also need the information on the sales contract, date, identity of the buyer and seller, sales price and any contingencies and seller concessions. Fannie Mae and Freddie Mac allow seller contributions towards the buyer’s closing costs. Appraisers are required to adjust the appraised value based upon seller concessions.
A professional real estate agent will always assist the buyer in going through the appraisal process. They can refer the buyer to appraisers, help make the appointment with an appraiser and offer the contract copy to the appraiser. However, as buyer, you need to pay attention to any deadline in the appraisal contingency and make sure the appraiser has enough time to process the appraisal. The appraiser needs to spend quality time on the appraisal and have sufficient time to make reports and forward the results to the lender. If you are a cash buyer, you also need to make sure that you have an appraisal contingency in the sales contract and obtain the appraisal before the deadline to cancel the contract based on the appraisal contingency.
In conclusion, if you have a federally related mortgage transaction, you need an appraisal for your property. If you refinance your mortgage, you need an appraisal. If you are a cash buyer and you want to verify that you are not overpaying for your property, you need an appraisal. As a buyer make sure you have sufficient time for the appraiser to conduct their research and complete their report before your contingency deadline. Professional real estate agents will always offer their help and knowledge to guide the buyer and seller to smoothly complete the appraisal process and the transaction.