Home Appraisal process and its significance
Updated: Apr 25
What is an appraisal?
An appraisal is a process of estimating the fair market value of the property. An appraisal is done by an appraiser, a licensed third party professional. An appraisal is an important part of the home buying process and in some refinance transactions or buying a second mortgage. Lenders need appraisal of the home to make sure their finance is protected before issuing a mortgage loan. The home acts as a collateral for the mortgage. The home appraisal value may be influenced by number of factors such as location, age of the home, number of bedrooms and bathrooms, square footage, storage space, home renovations etc.
What is an appraisal contingency?
An appraisal contingency is a condition that has to be met before the purchase contract becomes binding. An appraisal contingency is a conditional contract in which the buyer has the option to back out of the purchase contract and walk away with the Earnest money deposit if the value of the home doesn't appraise to a certain value. Earnest money is a small percentage (usually 1-2%) of money that is usually deposited by the buyer to show the seller how serious they are in purchasing the home.
If a contract had an appraisal contingency and the appraisal didn't appraise to a certain value, the buyer may rescind the contract and walk away with the earnest money.
If the appraisal value didn't appraise to a certain value and the buyer doesn't have an appraisal contingency, then the buyer may lose the earnest money amount while rescinding the contract.
How does it work?
Lenders usually require the buyers to do an appraisal before sanctioning the loan to make sure their finance is protected. The buyer only pays for the appraisal but cannot select the appraiser. An appraiser appraises the home by making a site visit and looking at different features of the home both interior and exterior and using CMA, by assessing the values of the nearby homes that are recently sold and their features, condition of the home, any renovations done on the home etc. Appraisers usually do not consider the personal items while appraising the property. Once the appraiser finishes the process, an appraisal report may be received which has all the details about the valuation of the property. It might be shared with the buyer, buyer's agent and lender and sometimes to the seller and seller's agent.
Types of Appraisal approaches
Typically, there are three methods of approach in the appraisal process. They are Sales comparison approach, Cost approach and Income approach. The two common methods used for the residential properties are Sales comparison approach and Cost approach. Commercial and rental properties are usually appraised by the Income approach.
Sales Comparison Approach - The appraiser determines the value of the property by comparing it to the values of the properties that are recently sold nearby which are called as comparables. Every property is unique, so the appraiser increases or decreases the value of the property by comparing it to the features of the comparables. This is the most common method of appraisal approach.
Cost Approach - The cost approach is an appraisal process in which the value is determined by calculating the replacement cost of the property. It is calculated by summing up the cost of the land and the cost required to replicate the building (includes material and construction costs) in event of disaster or destruction of the property. This approach is usually used while appraising unique residential properties which doesn't have enough comparables to compare with, hospitals, churches, schools, government buildings etc.
Income Approach - This approach is usually done for the commercial buildings, rental properties, apartments etc. It is also known as the Income Capitalization approach. The value of the property is appraised based on the income generating capacity of the property which is also called as the capitalization rate.
Capitalization Rate = Net Operating Income / Current Market value
Current Market value = Net operating Income / Capitalization rate
How long does it take?
Though the appraisal process takes only few minutes to hours, it might take few days, a week or more to receive an appraisal report. The process is influenced by various factors such as workload of an appraiser, rules followed by the state, type of an appraisal etc. Some of the factors that the appraiser may look for are condition and maintenance of the home, visible defects, Home improvements or renovations, Health and safety hazards.
How long is an appraisal good?
Typically, a home appraisal is good for around 30-180 days or more depending on the type of the loan or the shifts in the local market conditions with some exceptions in some scenarios. Appraisal usually lose its value if there are sudden ups and downs in the market, then the lender may require the buyers to have a new appraisal that reflects the current market condition. Appraisers use CMA - Comparative market analysis to compare the value of the home with the values of recently sold homes and their features. Certain loan types like FHA (Federal housing administration) and VA (Veteran's Administration) loan have separate rules for the appraisal process.
Home appraisal tips for the Buyers
If the appraisal value results in a lower value compared to the purchase price of the home, buyers may go with one of the following options.
You may dispute the appraisal by submitting a ROV (Reconsideration of value). Winning these disputes may not be easy and a solid evidence is needed.
You may renegotiate the purchase price with the seller to lower the purchase price of the property. Seller may or may not agree with the negotiation depending on the market condition. If the seller had multiple offers on the home, negotiation won't work.
You may put in extra money towards the down payment by paying the difference between the purchase price and mortgage loan amount.
You may walk out from the contract with your earnest money considering you have appraisal contingency added on to the contract.
Home appraisal tips for the Sellers
If the appraisal value results in a lower value compared to the purchase price of the home, sellers may go with one of the following options to avoid buyer walking out of the contract.
You have to make sure the home looks well maintained and clean both in the interior and exterior areas of the home. The curb appeal and the first impression that you get while entering the home is very important.
Apart from fixing the issues in the property, you may also consider making improvements that compliments the home both aesthetically and in functionality.
Showing the documentation of any improvements or upgrades made to the appraiser may increase the appraisal value of the home.
Home appraisal tips for the Refinancers
While refinancing, the more the appraisal value is better the chances of getting refinance and better loan terms because of the increased equity. If the appraisal value is low, you may not be qualified to do a refinance as the equity is low. Lower appraisal value means lower the value of home than the money you owe to the lender. This puts the lender's finances at risk.
You may make any upgrades or renovations to increase the value and functionality of the property. For example, changing the air conditioning and heating units usually have a considerable impact on the home value.
Show all the documentations of the upgrades or renovations to the appraiser rather than just pointing out on the upgrades.
Maintain and clean the home to make it look presentable. Make sure everything works in the home such as air conditioning and heating units, kitchen appliances etc. Declutter the home as much as possible.
What to do if an appraisal value is low?
A low appraisal may be due to a number of factors such as declining housing market, error in underwriting process by the underwriter, overpriced value of the home by the seller, property is not maintained properly or a number of foreclosures or short sales in the neighborhood. There might be an option where you may dispute the appraisal by submitting a ROV (Reconsideration of value). Winning these disputes may not be easy and a solid evidence supporting your claim may be needed to back it up such as sale price of homes nearby that has been recently sold.