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How To Understand Your Home Appraisal

A home appraisal is an estimate of your home’s value. It’s simply a professional appraiser’s opinion of what he/she thinks your home may be worth.

Why Do Appraisals Matter?

Mortgage lenders base your loan amount on the LESSER of the appraised value or the purchase price. Here’s an example:

$500,000 home with a $400,000 loan

You sign a contract for a $500,000 home with a $100,000 (20%) down payment. Your loan amount, in this case, would be $400,000 (80% of the purchase price).

Appraisal is $480,000

The appraisal comes back at a value of $480,000. $20,000 less than the purchase price.

Lender will loan $384,000

The mortgage lender is no longer willing to lend you $400,000 because that would represent 83.3% of the appraised value. The lender reduces the loan amount to $384,000, which represents 80% of the $480,000 appraised value.

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Your Three Options

Mortgage lenders base your loan amount on the LESSER of the appraised value or the purchase price. Here’s an example:

Pay

Make up the difference yourself (purchase the home for $500,000 and come up with a down payment of $116,000)

Ask Seller

Ask the seller to reduce the purchase price to make up the difference (purchase the home for $480,000 instead of $500,000, and use a down payment of $96,000)

Ask Lender

Ask the lender if there options available to make up the difference (e.g., change loan programs, add a second mortgage, add private mortgage insurance, etc.)

What If You Don't Agree With The Appraiser's Opinion?

Tough luck! No, seriously. Although you and I are entitled to our own opinion on the matter, the mortgage guidelines require the loan amount to be based on the LESSER of the appraised value or the purchase price.

How Does The Appraiser Determine Value?

Appraisers are usually required by the lending guidelines to compare your home with similar homes that have sold within the past 6 months. Then, they make adjustments based on the differences in the comparable sales (see illustration below).

In this example, Comp 1 sold for $440,000, but it didn’t have a finished basement. So the appraiser adjusted the sales price up by $50,000 to $490,000. This means the appraiser thinks Comp 1 could have sold for $490,000 if it was more like your home. Comp 2 had a 50% finished basement, and it only had a 1 car garage. However, it’s a little larger than your home. All things considered, the appraiser adjusted the sales price up by $19,000 to $469,000. This means the appraiser thinks Comp 2 could have sold for $469,500 if it was more like your home. The major differences between your home and Comp 3, are that Comp 3 is a little bigger than your home and it has a 3-car garage. So, the appraiser thinks Comp 3 could have sold for $477,000 if it was more like your home. In this example, the appraiser thinks your home is worth $480,000 based on the comparable sales (and all the adjustments outlined above).

Your Home
$ 0
Sales Price
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Square Footage
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Finished Basement
0 Cars
Garage

Figure 1

Comp 1
$ 0
Sales Price
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Square Footage
$ 0
Adjustment
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Finished Basement
$ 0
Adjustment
0 Cars
Garage
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Adjustment
$ 0
Total Net Adjustment
$ 0
Adjusted Sales Price of Comparable
Comp 2
$ 0
Sales Price
0 ft
Square Footage
$ 0
Adjustment
0 %
Finished Basement
$ 0
Adjustment
0 Cars
Garage
$ 0
Adjustment
$ 0
Total Net Adjustment
$ 0
Adjusted Sales Price of Comparable
Comp 1
$ 0
Sales Price
0 ft
Square Footage
$ 0
Adjustment
0 %
Finished Basement
$ 0
Adjustment
0 Cars
Garage
$ 0
Adjustment
$ 0
Total Net Adjustment
$ 0
Adjusted Sales Price of Comparable

What Does This Mean For You?

Here are three things you may be able to do if the appraisal comes back different than your purchase agreement:

Renegotiate

Renegotiate the sales price if permitted in your purchase agreement. The benefit with this option is that you may save some money on the purchase price of the house. The drawback is that you risk losing the deal because the seller may not agree to renegotiate.

Down Payment

Increase your down payment. The benefit with this option is that you close the deal without worrying about renegotiating with the seller. The drawback is that you'll need a larger down payment and you may be paying more for the house than it's worth.

Ask Lender

There may be options available to help you make up the difference (e.g., change loan programs, add a second mortgage, add private mortgage insurance, etc.).

Source: CMPS Institute

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