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How Home Appraisals Work

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You've found your dream home. The asking price is $300,000 -- an amount you've already been pre-approved for by your bank. But is the home really worth that amount? That's the question at the heart of the home appraisal. The worth, or value of the property, will determine how much a lender is willing to give you to buy that particular piece of real estate.

This all-important step in getting the financing you need is the home appraisal -- an oftentimes-confusing part of the mortgage process in which both buyer and seller must depend on the expert opinion of a stranger. A real estate appraisal is simply that -- the expert opinion of a certified, state-licensed professional who determines the value of a piece of property. If your $300,000 dream home is really worth only $200,000, then the home is overpriced.

A home appraisal also protects the bank from getting stuck with property that's worth less than they've invested. And it protects you from paying too much for a house simply because it was love at first sight. The home appraisal is a no-nonsense factor in a decision that is often emotional for the buyer.

In this article, we'll take a look at the methods appraisers use to value property and find out what's included in the appraisal report. We'll debunk some common myths -- for example, will dirty dishes in the sink affect your home appraisal? What about a wet basement? We'll find out where the appraiser gets the information that determines the value of the property. And, if you get a low appraisal, what happens next?

Home Appraisal or Home Inspection?

A home appraisal is not the same thing as an inspection. If you're buying a home, you'll want to hire an experienced home inspector to point out any potential problems that could turn into costly nightmares in the future. Property appraisers will likely make note of any obvious issues, but they won't test your heat and air, check the chimney, or determine if your plumbing is up to code. That's the job of the inspector.

Home Appraisal Methods

When you apply for a mortgage, your lender typically requires the property to be appraised by one of their approved appraisers. This practice helps create more consistent appraisals and gives you assurance that the appraiser is properly licensed and certified. Even though the home appraisal is the lender's requirement, it's the borrower's responsibility. You usually pay for it as part of the mortgage costs at the time of closing. The cost is typically around $300 but can be more depending on the price of the property.

There are two primary appraisal methods for residential property. In the sales comparison approach, the appraiser compares the property with three or four similar homes that have sold in the area, often called comparables, or comps. The analysis considers specific components, such as lot size, square footage of finished and unfinished space, style and age of house, as well as other features such as garages and fireplaces.

The cost approach is used more for new property and is based on reproduction costs. The appraiser estimates the cost to replace the structure on the property if it were destroyed. The appraiser then looks at land value and depreciation to determine the property's worth.

The appraiser gathers information for the appraisal report from a number of sources, but the process often begins with a physical inspection of the property inside and out. Additionally, the appraiser may look at county courthouse records and recent reports from the local real estate multiple listing service.

The appraisal report generally includes:

  • an explanation of how the appraiser determined the value of the property
  • the size and condition of the house and other permanent fixtures, along with a description of any improvements that have been made and the materials used
  • statements regarding serious structural problems, such as wet basements and cracked foundations
  • notes about the surrounding area, such as new or established development, rural acreage, and so on
  • an evaluation of recent market trends of the area that may affect the value
  • a comparative market analysis that supports the appraisal
  • maps, photographs and sketches

To learn more about what's included in the report, take a look at this property appraisal form from Freddie Mac, the second biggest provider of residential mortgages. If you have questions about any aspect of the appraisal, ask the appraiser for clarification.

A common misunderstanding is that the appraisal amount is only for the house itself. In fact, the figure appraises the total value of the home and any other permanent structures, along with the land that the house is built on. This appraisal figure also determines the loan amount you can get to buy the property.

Now you learn that your dream home is valued at $249,000 -- a full $51,000 lower than the asking price! Your lender won't loan more than the appraisal. So what do you do? On the next page we'll explore how both buyers and sellers can recover from a low appraisal.

What do the appraisers really look at?

A common myth about the home appraisal is that curb appeal and general tidiness of the home will help bring a higher appraisal amount. While overall maintenance of the home and surrounding property is certainly a factor, details such as dirty dishes in the sink or a lawn that needs to be mowed do not affect the appraisal.

Recovering From a Low Appraisal

An appraisal of $249,000? The home seller learns that his $300,000 asking price is much higher than the actual property value. If you are the buyer, this figure means that the amount you can finance on the property is much lower than you expected. An appraisal value that is considerably lower than what you have offered should be a red light -- a warning that you may be paying too much for the property. So is the deal over? Is it time to panic and throw in the towel? Can anything be done?

First, take a look at what may have caused the low appraisal. It might be due to factors that the homeowner could correct, such as repairs or maintenance. If that's the case, the appraiser may be willing to take a second look and adjust the appraisal accordingly.

You always have the option to order a second appraisal. This may be a good idea if the first appraiser is inexperienced or unfamiliar with the area where the property is located. However, be sure to use an appraiser from a list recognized by the lending institution. It's possible that a second appraisal will uncover mistakes the first appraiser made. If you believe that an appraisal is simply not an accurate representation of the property's value, and the appraiser is not willing to listen to your concerns, you can go to your state's licensing agency for appraisers and file a complaint.

From the lender's standpoint, however, the mortgage transaction is at a standstill until something else happens. Perhaps the seller will lower the asking price or carry a second mortgage to make up the difference. Or, as the homebuyer, you may be willing to increase your cash down payment. It's possible that both buyer and seller can negotiate compromises that will satisfy the lender.

If, however, negotiations fall through and the appraisal is still too far below what the bank is willing to finance, then there's no choice but to cancel the transaction. You probably signed a purchasing contract stating your offer for the property, but it likely contains a loan contingency. This is a statement that allows you to cancel the contract and receive any deposit you paid the seller if you can't qualify to buy the property at the agreed terms.

A home appraisal is more than just another cost added to the buyer's bottom line. It's a protection for everyone involved in the home-buying process. It will help you make a more informed decision about purchasing a home.

For more information about home appraisals and other related topics, see the links on the following page.

Appraisals and the Mortgage Meltdown

You don't have to look far to see the gloomy forecasts about the housing industry. At the end of 2007, Washington Mutual, the nation's largest savings and loan, was accused of pressuring appraisers to inflate home values, thereby making more loans available to more people -- a practice that many experts believe contributed to the housing collapse [source: Seattle Times]. In response, Fannie Mae and Freddie Mac, both government-sponsored mortgage investors, announced that beginning in 2009, they would only buy mortgages from lenders that use independent appraisers. Additionally, the appraisers are required to adhere to a Home Valuation Code of Conduct [source: Office of Federal Housing Enterprise Oversight].

Lots More Information

More Great Links

Sources

  • American Society of Appraisers. "Consumer Smart: Appraisal Basics." http://www.appraisers.org/consumer/ (Accessed 5/7/08)
  • Appraisal Foundation. "What's it worth: A consumer's guide to appraisal and selecting an appraiser." http://www.appraisalfoundation.org/s_appraisal/doc.asp?CID=20&DID=407 (Accessed 5/8/08)
  • DeSilver, Drew. "WaMu accused of pushing appraisers to inflate values." Seattle Times. 11/2/07. http://seattletimes.nwsource.com/html/businesstechnology/2003989314_wamu02.html (Accessed 5/7/08)
  • Gormley, Michael. "Cuomo: Appraisers inflated home values." USA TODAY 11/1/2007. http://www.usatoday.com/money/economy/2007-11-01-291973972_x.htm (Accessed 5/7/08)
  • Illinois Business Law Journal. "Fannie Mae and Freddie Mac: Setting the Industry Standard." http://iblsjournal.typepad.com/illinois_business_law_soc/2008/04/fannie-mae-and.html (Accessed 5/7/08)
  • Office of Federal Housing Enterprise Oversight. "OFHEO, NY Attorney General, Fannie Mae, Freddie Mac sign agreements to combat appraisal fraud." 3/3/08. http://www.ofheo.gov/newsroom.aspx?ID=417&q1=0&q2=0 (Accessed 5/8/08)
  • Real Estate.com. "How much is a home worth?" http://www.realestate.com/tipsandtools/Preparing-to-Buy/How-Much-Is-a-Home-Worth-.aspx (Accessed 5/7/08)
  • Schroeder, Robert. "Fannie Mae, Freddie Mac in appraisal agreement." The Wall Street Journal: Market Watch. 3/3/08. http://www.marketwatch.com/news/story/fannie-mae-freddie-mac-appraisal/story.aspx?guid=%7BF687AD1A-9FF3-48DE-93DC-80EEEEBF813A%7D (Accessed 5/7/08)
  • U.S. Department of Housing and Urban Development. "100 Questions & Answers About Buying a New Home." http://www.hud.gov/offices/hsg/sfh/buying/buyhm.cfm (Accessed 5/7/08)
  • Wilmington Trust. "Beware of high appraisals." http://www.wilmingtontrust.com/wtcom/index.jsp?fileid=1182518170341 (Accessed 5/8/08)

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