The appraisal process is one of the most common reasons why real estate transactions fall apart. According to a 2021 survey by the National Association of Realtors (NAR), 11% of sales contracts were terminated due to appraisal problems, and 22% of contracts were delayed due to appraisals.
A home appraisal is a professional assessment of how much a property is worth. It’s typically a non-negotiable part of the closing process. The appraisal will be one of the first steps in the closing process, typically paid for by the buyer. The lender will order the home appraisal during the mortgage approval process, but won’t ultimately pay for it. While the buyer pays for it in most instances, in some areas, the seller may pick up the tab.
Lenders require appraisals to protect their investment and confirm that the buyer is getting a fair price. Since it’s the lender that requires it, appraisals are not required for cash transactions. Before financing can be approved, the appraisal has to come in at least at the sale price to ensure the home is valued properly.
Why the Appraisal Matters
The difference between a property’s value and the homeowner’s loan amount represents the homeowner’s home equity. Building wealth through home equity makes it less likely that homeowners will fail to repay a mortgage if they experience financial hardship. Therefore, property valuation is a critical input to the risk evaluations that surround the lending process.
While it is an extra cost and can cause problems, it’s also protection. Ultimately it stops buyers from paying too much for a property and can be used as leverage to renegotiate a deal.
Are a Home Appraisal and Home Inspection the Same Thing?
First-time home buyers often confuse a home appraisal with a home inspection. Both occur before the transaction goes through and can make or break a transaction, but they are entirely different examinations of the home. Home inspections aren’t typically required by lenders like appraisals are, though different types of mortgage loans may have different requirements.
A home inspector is looking for issues that impact the integrity of the structure. For example, HVAC, moisture intrusion, plumbing, foundation, and other systems. On the other hand, appraisers look for impact on value.
Both are important for buyers to make educated decisions on their purchases.
Problems that affect closings
An appraiser’s opinion of value is very dependent on that appraiser’s selection of comparable properties and the adjustments and weighting the appraiser applies to those selections. This decision has subjective elements that depend on the expertise of the appraiser and the appraiser’s familiarity with the neighborhood, resulting in a natural imprecision of the appraiser’s estimate of the home’s value.
What happens when the appraisal comes in low?
When an appraisal comes in low, the buyer’s mortgage lender will not lend more than the appraised value. This is more common in:
- Neighborhoods with homes that are rapidly appreciating (might not reflect the prices sellers are currently being offered)
- Rural areas, where homes and properties can’t easily be compared to one another.
On the other hand, a higher appraised value can give buyers more home equity and a good deal on the property.
What Causes Low Appraisals?
It’s common to have appraisal issues in a strong sellers’ market where prices are escalating at a fast rate. The reason is that appraisers use comps dating back to 5 months’ history. So even if you were able to compare 2 identical homes 5 months apart, the more recent appraisal would have a higher price simply due to increased demand over time. If the appraisal comes back too low, the buyer and seller usually renegotiate the price and meet in the middle. So for example, if the original contract price was $255,000, and the appraised price comes in at $250,000, the buyer and seller typically agree to change the purchase price to $252,500
When this happens, buyers have options:
- Get a second look
- Renegotiate Purchase Price
- Buyer Exercises Their Appraisal Contingency And Walks Away From The Sale
- File an appeal if the appraisal is believed to be inaccurate
What does an appraiser look for?
Appraisers typically examine:
- Property’s condition
- Property’s attributes
- Neighborhood attributes
Each of these factors can impact a home’s value, either by raising it or lowering it by a couple of thousand dollars.
How is Appraisal Bias Avoided?
When a home is undervalued as a result of discrimination, it not only hurts the homeowner, but it can hurt the entire neighborhood. Because appraisers rely on comparable sales to evaluate homes, one undervalued home can lead to other homes in the neighborhood being undervalued, too.
Homeowners are encouraged to read the appraisal report and look for the following:
- Make sure the appraiser didn’t miss anything (i.e. square footage)
- Watch out for red flags in the appraiser’s comments, such as language referencing the racial or ethnic makeup of an area
- Look at the comparable sales the appraiser used
While for more than 50 years, federal law has forbidden racial, religious, and other discrimination in home appraisals, there is still progress being made to root out bias. In June 2021, the White House created a task force, called Property Appraisal and Valuation Equity (PAVE), for combating discrimination in the appraisal industry.
The task force examines potential enforcement under fair housing laws, regulatory action, and development of standards and guidance in close partnership with industry and state and local governments, to root out discrimination in the appraisal and homebuying process. The task force is co-chaired by Marcia Fudge, secretary of the Department of Housing and Urban Development, and Domestic Policy Advisor Susan Rice.
For more information on PAVE and the resources available to homebuyers, click here.
What’s included in an appraisal report?
The appraisal report is a complex process with hundreds of checkboxes and data fields to fill out. The report typically includes:
- Explanation of the valuation
- A brief overview of local housing market trends
- Summary of the home’s characteristics
- Structural problems and defects
For an example of an appraisal report, click here.
Problems with appraisals happen and can cause delays, but they don’t have to make or break a deal. But in most cases, by working with a real estate agent and your lender, you can resolve these problems and move on to closing.