You have spent months searching for the perfect home and now you have found it. You haggled with the seller and you finally agreed on a price. While you are getting your home inspection completed, your lender has hired a real estate appraiser to appraise your purchase. It looks as if everything is finally going your way – but then you get the phone call.
The lender calls to say that the appraised value is less than your purchase price. Oh isn’t that just great! The lender informs you that he cannot write the loan unless you come up with the difference. But you have everything you own into this deal already. What happened? And what is more, what can you do about it?
How the Appraisal Process Works
An appraiser is not out to ruin your deals. He wants you to close on this as much as the other guy. But he has been hired as a neutral third party to make sure that the market value of the property is equal to or greater than your purchase price. You do not want to overpay for the house, no matter how much you love it, and your lender doesn’t want you to over pay either.
After inspecting the property, a real estate appraiser will head back to his office and determine the value of the property. He will look at the value of the land and the construction value of all of the improvements, less the depreciation. This is called the Cost Approach.
Then he will go find at least three recent sales that are in as close proximity, size and construction quality as possible. If there are any differences between these comps and the subject property, he will make monetary adjustments to each of the comps. For example, let’s say the house you are buying has 2,300 square feet but the comparable has 2,600. The appraiser will multiply the additional 300 square feet by the market value and then subtract it from the sales price of the comparable. From these adjusted figures, he determines a value to your property.
Why is the Appraisal Less than the Purchase Price?
If the appraisal comes in for more, we are all ecstatic and praise the merits of the appraiser. But, if he says the property is worth a little less than the purchase price, we freak out and claim that the appraiser is an idiot. Well, it is not that simple.
The reality is that the appraiser thinks of homes in a range of value rather than one concrete number. For example, say your offer on the 2,300 square foot 3 bedroom/2bath is $198,000. If 100 hundred people made an offer on that property would all of the offers be $198,000? No but I bet that 80% of them would fall between 5% either side of the purchase price say $188,100 to $207,900. In reality, that property is worth between $188,100 and $207,900. Any offer in that range would be reasonable.
That makes sense, right? But the problem here is that the lender wants one number to work off of. What is more, lenders also have their own guidelines on what makes an appraisal acceptable for underwriting. The appraiser is balancing between all of these factors. If he lacks perfect comps and his adjustments are too high or too many, the lender may not accept his appraisal at all – even if he meets the sales price. Which is still a problem for you.
What Can You Do with a Low Appraisal?
The first thing is to ask yourself if the appraiser is correct, do you want to still purchase the home at your purchase price? Should you negotiate a lower price? Speak to your real estate agent about it.
The next step would be to have your lender contact the appraiser and see if there is some “wiggle-room.” Could he perhaps use a different comp? Could an adjustment be altered just a smidge to push up the value? Is the purchase price within the appraiser’s range of value? Often a little tweak is all that is needed.
If those fall through, then the choice is to either pay more out of pocket to close the loan or to start shopping for another home. That choice is entirely up to you, but regardless of your decision, aren’t you glad you know the true worth of the property?
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