Everything you want to know about a real estate appraisal!

A real estate appraisal is the process through which an appraiser determines the current fair market value of the subject property. The Uniform Standards of Professional Appraisal Practice (USPAP) sets forth the procedures and ethical standards to be followed by appraisers. “The appraiser investigates the characteristics of the subject property that might impact the property’s value. The appraiser also investigates the nature of the market for that property, competitive properties, and the buyers and sellers who constitute the market for that property type. The principles of supply and demand, substitution, balance and externalities help explain shifts in value.” (appraisalinstitute.org)

I am buying a home. When do I order an appraisal? Once most or all of the contract contingencies (like the inspection period) are dropped, the lender will order an appraisal of the property. This will be at the cost of the buyer and is around the $250-450 range in KY. The lending institution will pick the appraiser and verify that there is no conflict of interest between parties before completing the appraisal. A conflict of interest could be any connection that may sway the final valuation of the property. For example, if your uncle is the appraiser, they would be more likely to under or over value the property to fit your wants than a stranger would.

Why is my lender making me get an appraisal? Unless paying a significant amount of cash down, there is usually always an appraisal required by the buyer’s lender. You may wonder why the appraisal is so important to the lender. The lending institutions want to make sure they are not paying out an amount higher than the current market value of the home. Their goal is to make that loan money back with interest. If the mortgage amount is higher than the property value, the chances of the buyer defaulting are greater.

Buyers should be interested in the results of the appraisal as well. If they owe more on the mortgage than the fair market value of the home, the buyers are immediately starting out with negative equity. In this imaginary scenario, say you have a mortgage of $200,000 and a home valued at $150,000. You want to sell the home tomorrow. To sell the home and close the mortgage, you would have a payoff amount of $200,000, but a contract price to sell to a new buyer at $150,000. At the closing of this imaginary sale, you would have to pay the difference of the loan amount and sale price ($50,000). Typically, when selling our home, we expect to make money, not pay money.

What if the appraisal valuation comes in higher than what I agreed to pay for the home? As you are the buyer, congrats! You’re starting out with a positive equity in the home on the day of closing! That means that in theory, the appraiser believes that someone in the market would pay more for the home than you are paying.

What if the value is lower than I have contractually agreed to pay? No need to freak out yet. Luckily, our GLAR contract allows for three options:

1. You can ask the seller to lower the agreed upon price of the home to the amount of the appraisal, since fair market value will be the maximum amount of the mortgage.
2. You can keep the sales price the same as originally & bring the difference of the sales price and mortgage amount to closing. If the appraisal came back at $300,000 and you originally agreed to pay $315,000, you’ll need to have that extra $15,000 cash at closing.
3. As the buyer, you can terminate the contract & find a different home.

It is important to add that you may be able to find a happy medium between options 1 & 2. In the example in #2, maybe the seller is willing to lower the price by $8,000 or $10,000, but not the full $15,000. You, as the buyer, can bring the other $7,000 or $5,000 to closing in cash, respectively.

Hopefully, this can help you with your buying process! Check out the full PDF referenced, here: https://www.appraisalinstitute.org/assets/1/7/understand_appraisal_1109_(1).pdf.