Buying real estate often requires some serious haggling between home buyer and seller, to arrive at a price that they're both willing to accept. But even if you reach an agreement, the negotiations may not be over. If you're a buyer who needs a mortgage, most lenders will require that you obtain a home appraisal. So that means you'll need to get one more opinion on how much the property is worth.
Lenders require a home appraisal before they’ll provide a loan, for the simple reason that the home serves as collateral for your mortgage. If for some reason you end up unable to make your mortgage payments, the lender will have to foreclose upon your home, then sell the property to recoup its costs. So it makes sense that it would want a home appraisal to help determine the property is worth that large chunk of change it's handing over!
Homeowners may also need an appraisal when they refinance a home or take out a home equity loan (HELOC).
If all goes well, the home's appraised value will end up at the price you'd agreed to pay. But the home appraiser could also report that the home valuation is higher—or lower—and this has ramifications for the whole deal.
But never fear. Below, we walk you through everything you need to know about the crucial appraisal process, and how to handle whatever appraisal results come your way.
What appraisers do
To do a home appraisal, an appraiser considers these main criteria: location, structural condition, additions or renovations, and recent sales of comparable homes, or comparable sales. Comparable sales play the most important role when determining valuation, says Rick Phillips, an appraiser and real estate agent in Vienna, VA.
“We’re looking for homes sold within the last six months that are equivalent in the numbers of rooms, square footage, upgrades, and location to the home that’s being purchased,” he explains.
If a real estate comp isn’t an exact match—which is typically the case—an appraiser will make adjustments in order to fairly estimate the market value of the real estate you want to buy.
For example, if a recently sold single-family home has four bedrooms, and the home being purchased has only three bedrooms, the appraiser will make a market-determined deduction from your home's assessment.
A typical real estate appraisal costs around $300 to $500 and is usually paid for by the home buyer upfront. But although the appraiser is hired by the buyer, “The appraiser doesn’t represent the seller or the buyer,” says Joe Parsons, a senior loan officer at PFS Funding in Dublin, CA. And although appraisers work to protect a lender from entering a bad deal, they don't work for the lender, either. Real estate appraisers are merely there to give an unbiased opinion about the home value.
How appraisals affect the sale
If the real estate appraises for the agreed-upon purchase price, you as the buyer are one step closer to settlement. If the appraisal report comes in higher than what you're paying, that's even better. For example, if you’re paying $500,000 for a home and the appraiser says the appraisal value is $515,000, you’ve instantly gained $15,000 in equity.
But if the appraisal comes in lower than you'd agreed to pay for the home, that could cause trouble.
Low appraisals tend to occur in hot housing markets, where home buyers are often forced to pay above market value for a home. The only problem is that a lender won't loan more than a home's appraised value, which could leave the buyer to cover the difference, says Chris Dossman, a real estate agent with Century 21 Scheetz in Indianapolis. But if a buyer isn't willing or able to pay the difference between the appraisal amount and the sales price, there are options:
- Negotiate with the seller. If the home doesn’t appraise for the contract price, the seller may agree to lower the sales price so the deal can go through. Dossman says this is the most common outcome.
- Appeal the appraisal. Sometimes called a “rebuttal of value,” an appeal involves your loan officer and real estate agent working together to find better comparable market data to justify a higher valuation. “Appraisers aren’t perfect,” says Parsons. “They make mistakes.” If you file an appeal, the appraiser will review the information and then make a judgment call on whether or not to adjust the valuation.
- Order a second appraisal. “It doesn’t happen very often, but it does when a buyer just absolutely has to have the subject property” and believes the first appraisal wasn’t accurate, says Dossman. The initial appraisal might be significantly off-base if, say, the appraiser overlooked a good comp or wasn’t familiar with the local housing market, especially if appraised values are rising rapidly. Granted, if the sellers are equally committed to keeping the deal alive, you might be able to persuade them to cover the costs of the second appraisal.
- Walk away. “It’s a bummer, but it may not be worth overpaying for a home,” says Dossman.
This is why, as ominous as the home appraisal process might seem, prospective borrowers should see getting an appraisal report as a safety measure that can help them avoid buying a home that is overpriced.
If you are refinancing your home, an appraisal prevents you from taking out a loan amount for more than the percentage of the fair market value of the home that your mortgage lender will approve.
To find an appraiser, you can ask your real estate agent for recommendations, or search by ZIP code at the Appraisal Institute.