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As many as 8% of all offers fall through due to appraisal issues, and according to the National Association of Realtors (NAR), financing issues account for 46% of delayed closings. Will yours be one of those 46%? If so, what can you do about it?
A property appraisal can make or break an existing purchase contract and will affect a lender’s loan commitment. Therefore, buyers need to understand the significance of an appraisal and what actions can be taken, if any, with an adverse appraisal report. This article will explain what appraisals are, why they are necessary, and what alternatives are available if an appraisal comes in too low or too high.
WHAT IS AN APPRAISAL?
An appraisal is a valuation of property – with structured and standardized formulations, data, and calculations to back it up. Unlike an estimate of value or a CMA (Comparative Market Analysis), an appraisal is performed by a licensed, independent, and neutral appraiser, usually at the request of the lender. An appraisal is a much more formal process that includes the assessment of the property, including the interior and exterior, along with the age, condition, and functionality of that property.
A licensed appraiser is required to have a minimum of 1,000 hours of experience along with the relevant classes and exams, while a certified appraiser is required to have 2,500 hours of appraisal experience. Needless to say, appraisers are well-trained in the valuation process.
WHY IS AN APPRAISAL NEEDED?
A lender will require an appraisal to be completed to ensure that they are not lending too much money relative to the property’s value. After the buyer applies for a mortgage, the lender selects the appraiser and orders an appraisal of the property to determine its market value. The appraiser inspects the property and prepares a report that includes a detailed property value analysis based on its location, condition, and many other factors. The lender reviews the appraisal report to determine if the appraised value is sufficient to support the loan amount.
If the real estate transaction is for cash and doesn’t involve a mortgage for the buyer, in most states, the buyer isn’t required to have an appraisal. However, it’s always helpful for the buyer to get an independent appraisal from a certified property appraiser, especially if the dollar amount of the transaction is significant. Overall, the appraisal contingency process is designed to protect the buyer, whether paying cash or obtaining a loan, from overpaying for a property. It also ensures that the lender’s investment is secured by a property worth the loan amount when a mortgage application is involved.
WHAT IF THE PROPERTY DOESN’T APPRAISE FOR THE AGREED-UPON PURCHASE PRICE?
If the appraised value of a property equals or exceeds the agreed-upon purchase price, the purchase can proceed to closing. In this case, the lender is assured that the amount being loaned is adequate because the property is worth the loan amount.
If, however, the appraised value comes in below the purchase price, there are a few alternatives for the buyer:
- Back out of the purchase. The lender appraisal contingency clause in the purchase contract allows the buyer to back out of the agreement if the property is not worth as much as negotiated, so one choice is for the buyer to simply back out of the purchase and get any earnest money deposit returned.
- Renegotiate the purchase terms. The buyer may renegotiate the purchase terms with the seller, such as a purchase price reduction, splitting the price difference with the seller, or some other equitable arrangement that both parties will agree to and the lender will approve.
- Pay additional funds to close. The lender may require the buyer to provide additional funds to make up the difference or the lender can decline the loan altogether. If the lender declines the loan, a buyer will need to work closely with the lender to determine which alternatives are still available.
- Contest the Appraisal. Although there is no guarantee, an appraisal might be challenged, especially if the data used for the appraisal was incorrect or if the comparable properties used for the appraisal were not very comparable or were outdated. It will usually be the seller or listing agent who contests a low appraisal in an effort to avoid either of the first two alternatives.
This is an important phase of the home buying or selling process and one in which an experienced agent can make a positive difference. As your trusted advisor, I will work through the process with you and the lender to help you understand your options in the event of a low appraisal.
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