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As many as 8% of offers fall through due to appraisal issues, and according to the National Association of Realtors (NAR), issues related to financing and appraisals account for 46% of delayed contract closings. Will your property be one of them? 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 decision on a loan commitment. Therefore, sellers 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 actions might be taken if an appraisal comes in too low or too high.
WHAT IS AN APPRAISAL?
An appraisal is a valuation of the 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 lender’s request. An appraisal is a more formal process that includes the assessment of the property, including the interior and exterior, along with age, condition, and functionality. A licensed appraiser must have a minimum of 1,000 hours of experience along with the relevant classes and exams, while a certified appraiser must have 2,500 hours of appraisal experience. Suffice it to say appraisers are well-trained in the valuation process.
WHY IS AN APPRAISAL NEEDED?
The buyer’s lender will require an appraisal to be completed to ensure that they are not lending too much money in relation 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 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, the buyer may still want to get an independent appraisal from a certified property appraiser, especially if the transaction size 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 and ensures that the lender’s investment is secured by a property worth the loan amount.
WHAT IF THE PROPERTY APPRAISAL DOESN’T MATCH THE AGREED 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 loan amount is adequate because the property, or collateral, is worth the loan amount. Because the buyer pays for the appraisal, the appraisal report is not required to be shared with you, and you may not be told the actual appraisal amount.
You will, however, be notified if the appraised value comes in below the agreed purchase price. If that happens, there are a few alternative solutions to this dilemma:
- The Buyer can 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 appraisal is lower than the negotiated purchase price in the agreement. One option is for the buyer to simply back out of the purchase agreement and get any earnest money deposit returned.
- Renegotiate the purchase terms. You, as the seller, can renegotiate the purchase terms with the buyer, such as a purchase price reduction, splitting the price difference, or some other equitable arrangement that you both agree on and that the buyer’s lender will approve.
- Provide 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. The seller may wish to consider paying part of the buyer’s closing costs to cover the difference. Another option is to provide a 2nd mortgage if there is enough equity in the property and the terms are agreeable to both parties.
- Contest the Appraisal. This is not common, but an appraisal may be challenged, primarily if the appraisal used incorrect data or the comparable properties are not appropriate or outdated for the purpose of the appraisal. To be sure, this can be a judgment call on your part. To help avoid this, a good listing agent will be present during the appraisal to point out items that may otherwise be missed or overlooked that add value. A great agent can handle this professionally without implying that the appraiser cannot provide an accurate appraisal.
As your trusted advisor, I will work through the process with you and the buyer’s agent to help you understand your options in case of a low appraisal.
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