Do I Really Need an Appraisal?
You have just spent several weeks finding the perfect home, and your offer to buy it has been accepted by the seller! Now your mortgage broker has informed you that the lender has required an appraisal be performed on the property before final approval of your loan. Is an appraisal even necessary? And how will an appraisal impact my home purchase?
What is involved with a home appraisal?
A home appraisal is performed by an independent, qualified, licensed appraiser with the end goal of determining an accurate fair market value of a home. The appraiser will perform a site visit on the home and carefully document all of the home’s dimensions, features, condition and other characteristics that may add (or detract) from its value.
The appraiser will then look to find several comparable homes within a short radius that have recently been sold. Using this comparison method, the appraiser will attempt to establish a baseline value for the comparable group of homes. Using this value, the appraiser will determine whether the home in question (a.k.a., the subject property) has any features that would merit a premium or an adjustment to the baseline value to establish the subject property’s estimated fair market value.
Typically, the cost of an appraisal for a home is around $500 - $600, depending on the agency the lender specifies. This cost is typically paid by the home buyer, but, as with all things, this can be negotiated in the purchase contract.
How does an appraisal affect my mortgage?
If you are getting a mortgage from a conventional lender, whether your new home purchase requires an appraisal is completely out of your hands. The lender is subject to the regulations of the Fair Housing Finance Agency and the underwriting standards of Fannie Mae or Freddie Mac. Plus, the lender will typically want an appraisal to be completed to get a better gauge of the loan’s risk. A $200,000 mortgage on a home worth $400,000 is a much less risky proposition for the lender than a $350,000 mortgage on the same property.
One key thing to remember: a lender will never lend you more money than the property is worth, and can even apply standards in regards to the minimum amount of equity a borrower will have in the home. For example, if you find a home that you love, but your offer price is above the appraised value, the lender will require you to make up the difference in cash. Similarly, if the lender only agrees to loan you 90% of the home’s value (requiring at least 10% of equity) you will be required to bring in cash at closing of at least 10% PLUS any amount above the appraised value up to the purchase price.
Appraisals and mortgage insurance
If you apply for a conventional loan, your lender will require you to pay a monthly premium for mortgage insurance if your equity is below 20%. This could be an issue if you make an offer on a home and plan to put 20% down to avoid paying mortgage insurance, BUT the appraised value comes in lower than your offer price. In this case, some of the cash that you were planning on using for a 20% down payment will now be required to cover the difference between the purchase price and the appraised value. Even though you are putting the same amount down, your equity in the home will fall below 20% and you will be subject to monthly mortgage insurance premiums.
Conversely, your future home’s appraisal may come back higher than your offer price – in some cases significantly higher – and you would benefit immediately in the form of increased equity in the home.
But doesn’t my purchase offer reflect a fair market value?
Many people ask, “Since the buyer and seller have agreed on a sales price, isn’t that the fair market value?” The answer is not so simple. While the price a buyer is willing to pay does play a part in a home’s appraised value, there are often many circumstances which may artificially inflate a home’s value that might be unique to a specific buyer’s wants and not necessarily desired by the market as a whole. If a home’s entire back yard consists of an elaborate enclosed aviary, that may fetch a premium from a select few buyers, but, more likely, will probably be detrimental to most buyers looking for a place for kids to play.
The amount you and a seller agree upon is simply not enough for a lender to work with, and will demand a high level of security that they can recover 100% of your loan amount in case of default.
Can I ever purchase (or refinance) a home without an appraisal?
As mentioned above, there are many factors that determine whether an appraisal is required, and those factors are dictated by the entities that will ultimately buy and administer your mortgage.
Your lender will use automated tools that can scan for previous appraisals and other factors that can determine a home’s value and grant an appraisal waiver. If an appraisal waiver is granted, the lender accepts the stated value of the home as the fair market value and no appraisal is necessary. This can be beneficial as skipping an appraisal will save you time in the mortgage underwriting process as well as the cost of the appraisal. However, you could lose out on the chance that your home’s appraisal is significantly higher than previously thought and thus could qualify for more favorable loan terms because of your increased equity.
Although the cost and time of an appraisal are frequently a requirement for purchasing (and refinancing) a home that are out of your control, appraisals offer peace of mind to both you and the lender that your home’s value is “above water” relative to your mortgage. In the long run, a fair appraisal can work to your advantage.