For buyers and sellers there are a bewildering array of home valuations - Zestimate, assessed value, appraised value, market value, list price, and final sale price. In this series of blog posts we'll break down the various valuations you will see when you are looking to buy or looking to sell a home.
In this blog we'll look at the only value the lender cares about, the appraised value - specifically we'll explore how it is calculated and strategies buyers and sellers can adopt to minimize the impact if a property appraises for less than the agreed upon sale price.
When buyers apply for a mortgage, or existing homeowners wish to refinance their home, the lender will request an appraisal of the property. The outcome of this process is the property's Appraised Value. Lenders use this value to determine how much money they will lend to the buyer. An 80% mortgage means the lender will lend 80% of the appraised value NOT 80% of the agreed upon sale price - which is where potential issues arise.
Once a formal mortgage application has been made, and the Purchase and Sale agreement signed, the bank will order an appraisal (in some circumstances two appraisals will be obtained). Prior to the 2007 mortgage/financial industry meltdown there was a close (many argued too close) relationship between the lenders and appraisers -this led to some appraisals being inflated in value. Today there is clear separation between the appraisal company and the lender with the requests going to an appraisal clearing house, and the clearing house requesting appraisers to perform the appraisals. This sometimes leads to issues with the appraiser being from another area, county, and sometimes a different State which means that they often have a very limited knowledge of the local real estate market.
The appraisal is a very formal and prescriptive house valuation method. The appraiser will visit the home to verify the house characteristics and evaluate the house condition e.g. age of kitchen. They will then compare this to recent home sales in the immediate area. The appraisal will then take the other homes' sales price and adjust them to factor in differences with the home being appraised e.g. extra fireplace +$1,200, different living area (add or subtract accordingly) etc. These valuations are then averaged and an appraised value is calculated.
Even though this seems like a very formal process it still has its inaccuracies and inconsistencies. One area of frequent issue are basements as they are often handled inconsistently across appraisal companies and towns (public records in some towns count the basement as living space, others do not). A living area 'substantially' below grade is often ignored in the appraisal. It does not matter that this area is finished to a very high standard, or that there is a home theatre or gym in the basement. Issues arise because a prospective home buyer will obviously see value in these areas and the final sale price will reflect these features, yet the appraised value will not.
Why does the appraised value matter? As we mentioned previously lenders will only lend funds up to a certain percentage of the appraised value e.g. 80% of appraised value if they are looking for 80% financing, as opposed to 80% of the agreed upon sale price.
What happens if the appraisal value is higher than the agreed upon sale price? Well done - your negotiating tactics worked and you successfully bought the home for less than the market value.
What if the appraisal value comes in low? In order to look at this situation in detail let's put some real numbers to the problem. Let's assume that the price where buyer and seller agreed (the final offer price) is $600,000. Let's say the buyers are financing 80% of the offer price (that's a loan of $480,000 that they're looking for), and so this means that they have a down-payment of $120,000 in order to buy the home.
But let's assume the property appraises for $580,000 - how does this changes the numbers above? The buyers are still financing 80% but the bank will use the appraised value they will lend against which means they will lend $464,000, but the buyers need to pay the agreed upon $600,000 for the home, so the down-payment requirement because of the lower appraisal has now increased from $120,000 needed to $136,000 needed - a difference of $16,000 because of the lower appraisal.
What happens when it appraises lower than sale price?
In this situation a number of solutions are possible:
- The buyers can increase their down-payment to cover the additional funds required ($16,000) in the example shown above.
- The buyer can increase their Loan to Value (LTV) and still borrow $480,000 which then means that they will be borrowing 83% of $580,000. This then creates requirements for Private Mortgage Insurance to be paid which is necessary whenever the LTV is higher than 80%. This is, of course, easier if the buyers are already putting down a larger down-payment, for instance, 30% and so only need to borrow 70% (before the adjustment required due to the lower appraised value).
- Buyer and seller can agree to reduce the final sale price to match the appraised value thus reducing (or eliminating) the extra downpayment funds the buyer has to find. This is quite rare.
- If none of the above are options, then the buyers may be able to exit the contract based on the specific details of their mortgage contingency.
The appraised values are not in the public domain so we do not have accurate data on the number of homes where the appraised value is less than the final sale price. Although one study by QuickenLoans in August 2015 shows that homeowners are increasingly overvaluing their homes in comparison to appraisers' opinions of home values, on average, 2.33% lower than homeowners' estimates. If we look a little closer at this data we see that it varies across the country (see the diagram below).
In the Boston Metropolitan area the appraisers' opinions of home values, on average, are 1.63% higher than homeowners' estimates. In 2015, the MA Properties Online team helped 25 buyers and there was only 1 case where the appraised value was lower - this was caused by the appraiser not including a finished area slightly below grade and in this specific scenario the buyers increased the amount of money they were putting down; in all other cases the appraised value matched, or was very close to, the final offer price.
If you want details on this topic you can read more at www.quickenloans.com/press-room/indexes/
So, as a seller how do you ensure that appraisal issues do not occur with the sale of your home? Understandably a home appraising for less than the agreed upon sale price causes the buyers to wonder if they have overpaid for a home and taints their joy of buying the home. The MA Properties Online team when representing the seller, always meets with the appraiser when the appraisal visit is scheduled and provide the appraiser with local market statistics and recent comparable sales. This is especially necessary if the appraiser is an out of town appraiser who is not as familiar with the local market as the agent, and involves explaining what has been transpiring in the local market and specifically with the sale of the home. If the home had competing offers on it, and how many, and the characteristics of the offers, is all vital information that the appraiser needs to know.
If you have any questions about any of this then please don't hesitate to reach out to one of us. We would be more than happy to help.