Once you connect with a great real estate agent, they’re going to start throwing terms at you that you’ve probably heard of but may need a crash course in.
One of those terms is the home appraisal. As in, “Once we start submitting offers, we’ll want to schedule the appraisal as soon as possible.”
So what is the home appraisal process? Why do you need to appraise the value of a home if you and the seller have already agreed upon a price? Why is there an urgency to get a home appraisal during closing? And what are you supposed to do with the information?
What is a home appraisal?
A home appraisal is when an independent third-party appraiser comes in and gives an appraised value of a home that’s under contract (i.e., in the process of being bought).
To prevent confusion, here’s how the appraised value is different from a few others:
Appraised vs. assessed vs. market value
- The appraised value is determined by a licensed third-party appraiser and is used to reassure your lender that they’re not letting you borrow more than the house is worth.
- The assessed value is what the city thinks the house is worth and uses that number to calculate your property taxes.
- The market value is what the market thinks the house is worth based on supply, demand, etc. Basically, this manifests as the offer price that the seller accepts.
So, when is the home’s value appraised, and why?
When does the appraisal occur during the home buying process?
The appraisal typically occurs during your due diligence period.
Due diligence, as you may recall, is the period of closing when you, the homebuyer, can still back out without consequence.
The appraisal is a crucial part of due diligence because it tells you and your mortgage lender how much the house is really worth, regardless of how much the seller thinks it’s worth.
But again, if you and the seller have already agreed upon a price, why does a third opinion even matter?
Why is a home appraisal necessary?
Even after the seller has accepted your offer price, getting the home appraised accomplishes a few things:
- It ensures that you’re not getting ripped off.
- It gives you some negotiating power if it comes in low.
- It shows your mortgage lender how much their collateral is worth.
Let’s unpack no. 3 because it’s really the main reason why appraisals get done.
Ever wondered why mortgage interest rates (5%) are so much lower than credit card interest rates (30%)?
It’s because mortgages are types of secured loans, meaning they’re backed by collateral. Collateral is something the lender can repossess from the borrower in case they default on the loan.
In the case of a mortgage, your collateral is your house.
Therefore, mortgage lenders want an objective, professional opinion on how much their collateral is worth before loaning you money. They can’t rely upon what you and the seller think it’s worth, hence the appraisal.
What does an appraisal report look like?
Check out this sample appraisal report, courtesy of James Dougherty Appraisers.
Notice how the appraiser factors in not just the home’s condition and floor plan, but also the appraised value of “comparable” property nearby.
Now, let’s say you’ve just received your own appraisal report. What should you do with it?
What should I do with the information in my appraisal?
You’re welcome to read through the whole thing, but the most important number is right up top: the appraised amount. That number will dictate your next move.
(Keep in mind, also, that the seller doesn’t see the appraisal — so the ball’s in your court!)
- Appraised value = offer price. If the appraised value lines up with the offer price, you’re golden. The seller valued their own property well.
- Appraised value > offer price. If the appraisal value comes in higher than the offer price, that just means that you got a good deal. Don’t tell the seller!
- Appraised value < offer price. If your appraised value comes in lower than the offer price, things get a little more complicated.
Let’s say a seller accepts your offer of $400,000 and the appraisal comes in at $390,000. That creates an appraisal gap of $10,000.
Appraisal gaps can be a big liability for both buyers and sellers because, as you may recall, lenders will only loan enough to buy the appraised amount. If the buyer can’t make up the difference, they may have to pull out of the deal.
Therefore, as the buyer, you have a few options when facing an appraisal gap:
- Plug the gap with cash. If you have the $10,000, you might consider simply plugging the gap with cash just to complete the sale.
- Renegotiate with the seller. Even in a seller’s market, the seller may come down to fair market value in order to avoid the hassle of having to relist their home for sale.
- Request another appraisal. If you firmly believe the house was under-appraised, you can ask your lender to order another appraisal.
- Back out of the sale. If you can’t make up the cash to plug the gap, or you simply don’t want to overpay for the home, you can simply back out of the sale.
It’s worth noting that you can back out scot-free and keep your earnest cash if:
- You are still within your due diligence period, or
- You and your REALTOR® wrote a standard appraisal contingency into your contract that lets you bail out after a low appraisal.
So, wait a second. Will removing the appraisal contingencies from your offer make you more appealing to sellers on the front end?
How can gap coverage and appraisal waivers make your offer more appealing to sellers?
Home sellers don’t like appraisals. At best they reveal that they priced their house too low. At worst they give buyers room to negotiate or bail.
That’s why sellers love to see you give up some (or all) of your rights to an appraisal.
To preface, both of these methods are high-risk/high-reward. Talk to your REALTOR® before baking them into a contract.
Appraisal gap coverage
When you add appraisal gap coverage to your offer, you’re committing to cover some or all of the gap between the appraised value and the offer price.
- You make an offer of $400,000 with included appraisal gap coverage of $20,000.
- The appraisal comes in at $370,000.
- That means you’ll pay the seller $390,000.
Appraisal gaps are your way of telling a seller, “If the appraisal comes in low, don’t worry, I got you.”
Keep in mind, though, that you’ll need the cash to fill the gap since your lender won’t cover it.
An appraisal waiver
An appraisal waiver is an agreement between you and your lender to skip the appraisal process entirely.
And sellers love that.
Waivers not only save you ~$400 cash on the appraisal, but they let you finance the whole purchase amount since your lender is formally agreeing to accept the offer price as the appraised price.
However, the requirements for an appraisal waiver are steep.
You’ll need excellent credit and a 20% down payment, and your lender will have to approve the specific property for an appraisal waiver.
But since waivers are so appealing to sellers and can save tons of time and money, it’s definitely worth asking your REALTOR® and lender about the possibility.
Related: How to improve your credit score: step by step
Home appraisals can open a big can of worms during closing. Thankfully, they can often mean a win-win for buyers; a high appraisal means you got a deal, while a low one can give you grounds to negotiate.
In a seller’s market, you can greatly stand out by adding some gap coverage (if you have the cash) or possibly even waiving the appraisal altogether. Looking to craft the best possible offer to win in a crowded market? Head here next:
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