How To Understand Your Home Appraisal

Why Do Appraisals Matter?

Mortgage lenders base your loan amount on the LESSER of the appraised value or the purchase price. Here's an example:

  • You sign a contract for a $500,000 home with a $100,000 (20%) down payment.  Your loan amount in this case would be $400,000 (80% of the purchase price).

  • The appraisal comes back with a value of $480,000.

  • The mortgage lender is no longer willing to lend you $400,000 at the same terms, because that would represent 83.3% of the appraised value.

  • The lender reduces the loan amount to $384,000, which represents 80% of the $480,000 appraised value.

  • You have three options:

    • Make up the difference yourself (purchase the home for $500,000 and come up with a down payment of $116,000); or,

    • Ask the seller to reduce the purchase price to make up the difference (purchase the home for $480,000 instead of $500,000, and use a down payment of $96,000); or,

    • Ask the lender if there options available to make up the difference (e.g., change loan programs, add a second mortgage, add private mortgage insurance, etc.)

How Does The Appraiser Determine Value?

Appraisers are usually required by the lending guidelines to compare your home with similar homes that have sold within the past 6 months (aka Comparable Sales, or Comps).  Then, they make adjustments based on the differences in the comparable sales (see illustration below).

In this example, Comp 1 sold for $440,000, but it didn't have a finished basement.   So the appraiser adjusted the sales price up by $50,000 to $490,000.  This means the appraiser thinks Comp 1 could have sold for $490,000 if it was more like your home with a 100% finished basement.  Comp 2 had a 50% finished basement, and it only had a 1 car garage.  However, it's a little larger than your home.  All things considered, the appraiser adjusted the sales price up by $19,000 to $469,000. This means the appraiser thinks Comp 2 could have sold for $469,500 if it was more like your home.  The major differences between your home and Comp 3, are that Comp 3 is a little bigger than your home and it has a 3-car garage. So, the appraiser thinks Comp 3 could have sold for $477,000 if it was more like your home.  In this example, the appraiser thinks your home is worth $480,000 based on the comparable sales (and all the adjustments outlined above).

What If You Don't Agree With The Appraiser?

If you don't agree with the appraiser, there is little recourse for you. Just because you and the seller agree to a certain price, doesn't necessarily mean that is the market value. The appraisal protects the buyer and the lender in that it ensures the lender's collateral value is justified, and it ensures the buyer obtain's a professional opinion on the value of the home. After all, most people wouldn't want to overpay for anything.

 

However, if you do find legitimate flaws in the appraiser's report, most of the time you can submit a "Dispute of Value" to the appraisal company. Examples of errors that are worth noting are things like:

  • The appraiser incorrectly calculated Gross Living Area, and used comparables that are smaller than the home you're buying.

  • The appraiser incorrectly noted an inferior condition of the home you're buying and so used comparables that were also in inferior condition.

  • There are more recent comparable sales that are closer in proximity and similarity to the home you're buying that the appraiser should have, but did not use in their report.

  • The appraiser didn't value a parking stall for a property located in a metropolitan area where parking stalls have high value.

 

In these cases, it may be worth going through the dispute process to increase the appraised value of your home.

What Does This Mean For You?

Here are three things you may be able to do if the appraisal comes back different than your purchase agreement:

 

  • Option 1:  Renegotiate the sales price if permitted in your purchase agreement.  The benefit with this option is that you may save some money on the purchase price of the house.  The drawback is that you risk losing the deal because the seller may not agree to renegotiate.

  • Option 2:  Increase your down payment.  The benefit with this option is that you close the deal without worrying about renegotiating with the seller.  The drawback is that you'll need a larger down payment and you may be paying more for the house than it's worth.

  • Option 3:  Talk to your loan officer.  There may be options available to help you make up the difference (e.g., change loan programs, add a second mortgage, add private mortgage insurance, etc.).

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This is probably one of the most important financial transactions of your life. My commitment is to communicate and strategize with you every step of the way.  

Published 2/11/18

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