If you’re buying a home and financing it with a mortgage, you’ll need a home appraisal. You may also need one when you try to refinance your home. Anytime you borrow money using your home as collateral, lenders must know the home’s value. The only way to determine it is with a home appraisal.
What is a Home Appraisal?
A home appraisal is a report on a property’s fair market value or how much a home should sell for on the open market. Lenders use the appraised value to determine if a borrower qualifies for financing.
Lenders rely on the appraised value to ensure the home is worth enough for them to invest in. If a borrower doesn’t make his/her payments on the loan, the lender will start the foreclosure process and take possession of the home. Knowing the home is worth enough, they can sell it and make back the money they lost by the borrower defaulting.
How Does it Work?
When you apply for a mortgage, lenders order an appraisal from a licensed appraiser. The appraiser will visit the home’s interior and exterior. Appraisers take measurements, take notes about a home’s features and condition, and take pictures.
Appraisers then find recently sold homes in the area that are similar to the subject property. They use these homes and their sales prices to determine the subject property’s fair market value, or the value they’ll use to determine how much you can borrow.
Appraisers make necessary adjustments (higher or lower) to the comparable property values based on what’s better or worse about the subject property to arrive at the fair market value.
Who Needs an Appraisal?
Most people applying for a mortgage need a home appraisal. Here are the most common times you’d need an appraisal:
Buying a home – Before you buy a home, lenders need to make sure the sales price is equal to or less than the appraised value
Rate/term refinance – Before you refinance to get a better rate or term, lenders need to know the home’s value to make sure your loan-to-value ratio is within the loan’s guidelines
Cash-out refinance – If you have equity in your home, you can tap into it using a cash-out refinance. Lenders usually allow you to have up to 80% of your home’s current value outstanding.
Home equity loan or line of credit – You can tap into your home’s equity with a second mortgage either as a fixed rate home equity loan or adjustable-rate line of credit. Lenders usually allow you to have a total of 80% of the home’s value outstanding.
Who Pays for an Appraisal?
The borrower (you) typically pays for the appraisal. On average they cost between $300 and $500. You may also be able to negotiate with the seller to pay the appraisal fee for you if you can’t cover the cost.
What if the Appraised Value Comes in Low?
If the appraised value comes in lower than the sales price when you’re buying a home, you have a few options:
Pay the difference – If the appraised value is just slightly lower than the sales price, you can pay the difference in cash (in addition to your down payment). The lender will still base your loan amount on the lower appraised value.
Renegotiate with the seller – Ask the seller to lower the price to the appraised value. Sometimes sellers get overconfident about their home’s value but are willing to lower it to the fair market value once they see the appraisal.
Walk away from the sale – If the seller won’t renegotiate and you don’t have the cash to pay upfront (or don’t want to pay it), you can walk away from the sale.
What’s an Appraisal Contingency?
When you sign a purchase contract, you typically put down earnest money. This is money you put down in ‘good faith’ to show the seller you’re serious about buying the home. If you back out of the contract you give the seller the earnest money to make up for the time, he/she took the home off the market.
If you have an appraisal contingency on the contract, though, you won’t lose your earnest money. If the appraisal comes in low and the seller won’t renegotiate the deal, you can cancel the sale and keep your earnest money.
It’s important to limit the number of contingencies you put in a contract (there are many available), but the appraisal contingency is often a good way to protect yourself.
Are Home Appraisals and Home Inspections the Same Thing?
Many people confuse the home appraisal and home inspection. While they both provide reports about a home, they look at two different aspects of it.
A home appraisal determines a home’s value. The appraiser doesn’t do an in-depth inspection of the home’s functions or find any serious issues with it unless they are obvious. The appraiser’s job is to focus on the home’s value.
A home inspector looks at all aspects of the home’s functions, looking for things like leaky pipes, mold growth, an old roof, or utilities that don’t work. Home inspectors provide a 50+ page report that details every bit of a home’s inner workings, what’s wrong with the home, and areas of serious concern to help you determine if it’s a good purchase.
Final Thoughts
A home appraisal is necessary for almost any type of mortgage loan today. It’s how lenders make sure the home is a good investment for them should you not make your payments, and they have to foreclose on the property.
Think of the appraisal as a way to protect your investment in the home as it stops you from buying a home that’s not worth as much as you were willing to pay. It also helps you understand how much equity you have in a home to decide if borrowing from the home’s equity is a smart move right now.
