When lenders evaluate a loan application, whether the application is for a purchase or a refinance, there really are two approvals needed—the approval for the borrowers on the loan application and the property. Both have to be approved or it’s a “no go.” The borrowers are approved on multiple levels including sufficient income, established credit and a down payment among other important factors. The property must also be approved in terms of condition and value.
The property must be in good condition and noted so on the appraisal report yet it also must support the purported value as listed on the loan application. The property is the lender’s collateral in the transaction and uses the appraisal report to make the determination of final value. The lender doesn’t determine the value, an independent appraiser does.
What’s In Your Appraisal?
The lender orders the appraisal using the services of an appraisal management company who then orders the report from a list of approved appraisers. The lender has no influence on who the appraiser will be. The appraisal will consider the sales price of the home as listed on the sales contract then researches public records as well as the local multiple listing service for previous sales, then compare those sales to the subject property, usually before making a physical inspection of the home.
To help establish the sales price, the appraiser will look for homes in the neighborhood that have recently sold. Homes in a subdivision are typically similar in age and structure and provide the best indication of value. The appraiser will look for at least three houses that have sold within the previous three to six months. Sold properties are called “comps,” short for comparable sales, and the sales must have occurred within the last 12 months. The appraiser will also look for homes that are currently listed for sale, yet listings have less impact on value compared to an actual closed transaction.
The ideal comp will be in the neighborhood, sold and closed within the last 90 days and of similar size and structure. Comps that are closest to the subject property will carry more weight than one further away. Comps that are outside of the subdivision altogether will carry less weight. Sometimes a lender may disqualify such a comparable sale if the lender disagrees the comp is within guidelines.
Say there are three 3,000 square foot homes that sold for $300,000. That works out to $100 per square foot. Now consider that subject property is also 3,000 square feet and sold for $330,000, or $110 per foot. In this very basic example, the subject property is selling for $110 per foot, not $100. The appraisal may come in low unless the appraiser can find better comps or make adjustments to the property that will support the higher sales price.
The higher priced home might have a magnificent valley view, updated appliances and wood floors throughout. The lot may be larger as well or the home has been extensively remodeled. In this instance, the appraiser will make adjustments in the appraisal report to support the higher value. All appraisals will have adjustments.
Value Coming In Low: Next Steps
But what if there is no view or recent renovations? What if the appraiser can’t support the higher value based upon recent sales? Then the appraisal will come in lower than the sales price and the buyer has only a few options—renegotiate the sales price based upon the newly appraised value, make up the difference or cancel the contract.
Lenders issue a loan based upon the lower of the sales price or appraised value. Again using this example, if the appraisal came in at $320,000, 80 percent of that is $256,000 for a conventional loan without mortgage insurance. The buyers must make up for the $10,000 difference in valuation plus the 20 percent down payment of $64,000 for a total of $74,000. Or, instead of coming to the closing table with the additional $10,000, the buyers might consider taking out a second mortgage for that amount, keeping the first mortgage at $256,000. Now assume the seller doesn’t wish to renegotiate and you still want the home, what can they do?
First, you simply swallow hard and make up the shortfall. But before you do, your real estate agent can help. Appraisers aren’t infallible. It’s possible the appraiser missed a comparable sale. Your agent can compare the comps used with the closed sales listed in the multiple listing service, or MLS. If the appraiser missed one, the appraisal can be corrected.
Your agent may also know of a so-called “pocket” listing where a sale took place on a property that never made it to the MLS. The sale may also be recorded in the public record but without a sales price so the comp can’t be used. Or a distressed sale took place and the sellers had to sell quickly due to a pending foreclosure, a death in the family or a divorce. With this additional information, your agent can help bolster the sales price and adjust accordingly. Sometimes with a little value boost from the appraiser, you can finance the entire purchase price without extra money out of pocket.