As a buyer, unless you are purchasing your new home in cash, you most likely made your offer contingent on obtaining a mortgage. Mortgage lenders will require an appraisal on your home before they’ll provide a loan for the property since that property is the underlying asset that serves as collateral for the loan.
So What is an Appraisal?
An appraisal is a written estimate or opinion of a property’s market value completed by an appraiser. The value is based upon a market analysis of recent sales prices for similar properties in the area, and the property’s physical condition. The two main methods for appraising residential properties are the sales comparison approach and the cost approach. In the sales comparison approach, the appraiser compares the subject property with 3-5 recently sold similar properties (comparables or comps). The subject property is compared to the selected comps for any dissimilar features that would impact value such as size, condition, or improvements. In the cost approach valuation method the property value is based on the replacement cost of an equivalent structure. The market price for the property is equivalent to the cost of land plus the cost of construction, less depreciation. It is often most accurate for market value when the property is new.
What Does an Appraiser Look For?
The basic appraisal calls for information on the property. A typical appraisal report includes the subject and comparable property legal descriptions, sales price of comparable properties, square footage and price per square foot, lot size, age, condition, total rooms, appraised value, among hundreds of other identifying aspects of the property. The appraiser has the opportunity to comment or rate every aspect of the home, the property and even the utilities.
Why do Banks Appraise Properties?
If you default on the loan, the lender needs to make sure that they can sell the property to repay the loan. The lender uses the lower of the appraised value or purchase price in determining their loan to value ratio. So for example if you are getting a mortgage with 20% down on a property that you offered to pay $500,000 for, the bank should loan you $400,000 but if the property appraises at $480,000, the bank will loan you 80% of the $480,000 or $384,000. If the property appraises for $520,000 though, the bank will still only loan you the $400,000 since your loan is based on the lower appraisal value.
Who Benefits?
While the buyer pays for the appraisal, it is done on behalf of the lender. Lenders have their own approved appraisers but it is important to understand that the appraisers don’t work for the lender; they are independent professionals. In NJ, the appraisal must be done by a licensed or certified real estate appraiser.
Opinion of Value and Consumer Protection
So what happens if the appraisal comes in lower than the purchase price? Your protection depends on the specific language that is put in your purchase contract so make sure you discuss the process and options with your attorney during attorney review. If your contract is subject to the property appraising at the purchase price then you can cancel the contract or renegotiate with the seller on the purchase price. Another option if you still want the property is to put down a larger down-payment. So using the example from above of purchasing a property with 20% down for $500,000, if the appraisal comes in at $480,000, the buyer can put down the difference between the loan amount of $400,000 and $384,000 or the extra $16,000. Obviously, the buyer has to have the additional funds available. Your realtor can help you evaluate these options and negotiate with the seller on your behalf.
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