Facts About Residential Real Estate Appraisals
In Bankrate’s annual closing costs survey, the average appraisal cost around $405 in 2014. Buyers sometimes pay for the appraisal when it takes place and other times the fee is included in the closing costs paid on settlement day, the day the actual closing takes place.
Appraisals are an Important Part of Your Home Selling Transaction
A real estate appraisal helps to establish a property’s market value–the likely sales price it would bring if offered in an open and competitive real estate market.
The lender will require an appraisal when you ask to use a home or other real estate as security for a loan, because it wants to make sure that the property will sell for at least the amount of money it is lending.
Don’t confuse a comparative market analysis, or CMA, with an appraisal. Real estate agents use CMAs to help home sellers determine a realistic asking price. Experienced agents often come very close to an appraisal price with their CMAS, but an appraiser’s report is much more detailed–and is the only valuation report a bank will consider when deciding whether or not to lend the money.
About Appraisers and Appraisals
• Appraisers are licensed by individual states after completing coursework and internship hours that familiarize them with their real estate markets.
• The lender might use an appraiser on its staff, or contract with an independent appraiser. If you are allowed to choose the appraiser, and it isn’t someone the lender is familiar with, the results might be subject to review before they are accepted.
• The appraiser should be an objective third party, someone who has no financial or other connection to any person involved in the transaction.
• The property being appraised is called the subject property.
• The will probably pay for the appraisal when they apply for your loan.
What You’ll See on a Residential Appraisal Report
Appraisals are very detailed reports, but here are a few things they include:
• Details about the subject property, along with side-by-side comparisons of three or more similar properties.
• An evaluation of the overall real estate market in the area.
• Statements about issues the appraiser feels are harmful to the property’s value, such as
• poor access to the property.
• Notations about seriously flawed characteristics, such as a crumbling foundation.
• An estimate of the average sales time for the property.
• What type of area the home is in (a development, stand alone acreage, etc.).
Residential Appraisal Methods
There are two common appraisal methods used for residential properties A) Sales Comparison Approach and B) Cost Approach.
A) Sales Comparison Approach
The appraiser estimates a subject property’s market value by comparing it to similar properties that have sold in the area. The properties used are called comparables, or comps.
No two properties are exactly alike, so the appraiser must compare the comps to the subject property, making paperwork adjustments to the comps in order to make their features more in-line with the subject property’s. The result is a figure that shows what each comp would have sold for if it had the same components as the subject.
B) Cost Approach
The cost approach is most useful for new properties, where the costs to build are known. The appraiser estimates how much it would cost to replace the structure if it were destroyed.
So What Does the Appraisal Mean to You?
Buyer preapproval is accomplished early in the selling process, but final loan commitment usually hinges on a satisfactory appraisal. The bank wants to be sure its investment is covered in case the buyer defaults on the loan.
If the property appraises lower than the sales price, the loan might be declined, but that isn’t the only hurdle it must pass. Other facts on the appraisal can be a problem, too:
• The bank probably won’t like it if the estimated time to sell the property is longer than the area average.
• If the appraiser notes that entry to the property is from a private or shared road the bank might want to see a road maintenance agreement signed by everyone who uses the road, verifying that maintenance is shared by all parties.
Those are just a two examples of negatives that could stall the sale. The lender will study the appraisal carefully before determining whether or not the property qualifies to serve as security for the loan.
An Appraisal Isn’t a Home Inspection!
Appraisers make notations about obvious problems they see, but they are not home inspectors. They do not test appliances, look at the roof, check the chimney or do any other typical home inspection tasks. Never count on an appraisal to help you determine if the home is in good condition.
If the Appraisal Comes in Low
Don’t panic if the appraisal comes in low, because there are often steps that can be taken, see Solutions For Low Appraisals below, to make the deal work.
If the appraisal uncovers other problems, remember that most problems are correctable. Try to keep your cool and work through issues one step at a time.
Solutions for Low Appraisals
Don’t panic if the appraisal comes in low. It’s tough to remain calm when it appears the pending sale will fall apart, but both parties have options:
• Buyer can make up the difference in cash.
The lender cares about the appraisal only to the extent it affects the loan-to-value ratio. A low appraisal does not mean the lender won’t lend. It means the lender will only make a loan based on the ratio agreed to in the contract at the appraised value.
• The seller can lower the price.
If the home was overpriced or the value was inflated, often this is the best solution. It makes the buyer happy and the lender is satisfied. There is no guarantee that if the buyer walks away, the seller won’t receive a low appraisal from the second buyer’s lender, not to mention the time and trouble it takes to sell the property again. Sometimes a bird in the hand is best.
• The seller can offer to carry a second mortgage for the difference.
If the buyer really wants the home but cannot come up with the difference in cash, making payments or a lump sum payment at a later date to the seller is an option. After the escrow closes, sellers often retain the right to discount the second mortgage, sell it for less than face value to an investor. This is done occasionally, but not very often.
• Order a second appraisal.
First, if your loan is an FHA loan, ask the lender for a list of approved FHA appraisers. Either the seller or the buyer can pay for the second appraisal. Sometimes the second appraisal will come in higher than the first, especially if the first appraiser was inexperienced or made mistakes.
If your loan is a conventional loan, then it is subject to the rules of the Home Valuation Code of Conduct (HVCC). Barb Torres, an accredited senior appraiser says, “As soon as the parties find an appraiser is coming out who is not familiar with the local market, they have every right to contact the lender (preferably in writing) to DEMAND a local appraiser be used.”
• Supply a list of comparable sales.
Ask the agents involved to put together a list of recent comparable sales that justify the agreed-to sales price. Submit that list to the underwriter and ask for a review of the appraisal. Also, ask the agents to call the listing agents of pending sales to try to find out the actual sales price of those properties. Listing agents do not have to disclose the sales price, but many are happy to help out because they could find themselves in the same situation.
• Cancel the transaction.
Many purchase contracts contain a loan contingency. If the appraisal comes in low, the buyer does not qualify to buy the property at the agreed-to terms in the contract. A properly written loan contingency allows the buyer to cancel the contract and requires the seller to release the buyer’s earnest money deposit.
This is where all parties involved in the sale must step back and look at the possibilities and determine together if there is any way to come to a compromise to get the sale completed, if the appraisal comes in below the agreed to purchase price.