Most people purchasing or selling their home will eventually have to deal with a “home appraisal” at some point during the process. A home appraisal can affect the sale of property in different ways for both buyer and seller and the impact it can have on the transaction can sometimes be difficult to understand. So what exactly is the “home appraisal” and what is it used for?
What it Is.
An appraisal is a valuation tool used most commonly by mortgage lenders to affirm the value of a property that an applicant is attempting to purchase. Here the lender is hiring an independent third party known as licensed home appraiser (paid for by the buyer) to justify or establish the value of a home as part of their risk assessment process when underwriting a loan application.
Why it’s important
For the most part it is the bank or lending institution that is most concerned with the appraisal. For them, they view the buyer (applicant) as an investment and they want to ensure that lending them money to purchase a particular home is going to be wise and fruitful investment on their part. An appraisal is another way for the lender to ensure the property is worth the money they will be lending. The last thing the bank wants to do is give someone more money to buy a home than the property is actually worth because in the event the buyer were to default on their mortgage shortly after taking possession of the property the bank would be unable to recoup all of the money they lent the buyer by foreclosing.
In fact, in most cases the bank will prefer to have a bit of a cushion between the purchase price and the actual amount of money they lend the borrower. This part of their assessment is known as the borrowers Loan to Value ratio (LTV). Here the lender will often prefer the borrower put down 20% of the sale price to give the bank a nice cushion and better chance at recouping their investment if the borrower defaults. Most times borrowers who can make a 20% down payment on a home will be offered the best terms and rates by a lending institution and will avoid having to pay Mortgage Insurance (PMI). However, it is still very common for many borrowers to put down less than 20% and in some cases as little as 3.5% through first time home buyer programs.
Impact on the Sales Transaction
The appraisal is one of many hurdles a home sale must go through in order to complete the transaction. In order for the bank to give a borrower the loan the property will in most cases have to appraise at or above the sale price. This is important because the bank will always use the lower of the two numbers (sale price or appraisal) to base the value off of. This means the borrowers Loan to Value ratio (LTV) is determined by the lower number and should the appraisal come in lower than the agreed upon sale price the whole transaction could be in jeopardy because it will directly impact the amount of equity or cushion the bank feels they have in the investment.
Furthermore, a low appraisal can also make a significant impact on the borrowers mortgage payment. The change in LTV can effect the payment terms and PMI and end up costing the borrower more per month than they originally anticipated. If this happens the borrower may decide they do not want to move forward with the purchase. On the seller side, for a sale to fall apart at this point in the transaction means the property has likely been off the market for several weeks and they may have potentially lost out on other buyers for their home.
As you can see the appraisal is just one of many reasons it is important to work with a knowledgeable agent who can assist both buyer and seller throughout the transaction and avoid costly problems that prevent the sale of a home. A knowledgeable agent should be able to confidently determine whether or not a property will appraise at the correct value to ensure a smooth transaction with their in depth knowledge of the market, location, and comparable properties for sale.