When you enter into an agreement to purchase a home or investment property, the process will likely involve an appraisal and an inspection of the property. While many buyers, especially first-timers, think these two terms refer to the same real estate concept, they actually refer to two completely different parts of the homebuying process. Appraisals and inspections have some key similarities, but there are also several major differences that are important to know.
With that in mind, here's what all homebuyers and investors should know about appraisals and inspections and the key similarities and differences between them.
What is a real estate appraisal?
In simple terms, a real estate appraisal is an assessment of the property's value. Real estate appraisers will evaluate the property itself and take into account specific appraisal requirements, including its overall condition, the number of bedrooms and bathrooms, and any upgrades that have been completed. The appraiser will also evaluate the size and functionality of the land the property is built on.
In addition to property-related criteria, an appraiser will look at other factors, such as how "walkable" the property is to things like parks, shopping, and public transportation or the quality of the schools in the area. During the appraisal process, the appraiser will also analyze comparable properties that have sold recently to determine the property's fair market value.
The main purpose of a property appraisal is to confirm to a lender that the price a buyer agreed to pay for a property isn't in excess of its fair market value. If an appraisal finds that a buyer is overpaying, the buyer has three main options:
- The buyer can ask the seller to lower the sale price to be in line with the appraised value.
- The buyer can choose to make up the difference between the appraised value and contract price by increasing the amount of their down payment accordingly.
- If there's an appraisal contingency in the purchase contract, the buyer has the ability to get out of the deal.
In the case of investment properties, it's also worth noting that an appraisal might analyze a property's ability to produce rental income, in addition to its overall market value. This is because many investment property lenders, known as asset-based lenders, primarily base their decisions on the property's ability to generate enough income to cover all of its expenses with a reasonable amount of cushion.
What is a real estate inspection?
The point of an inspection is to identify things that should be replaced or are likely to need replacement in the near future. Technically, a buyer has the choice of whether to order a home inspection when buying a property, but virtually all buyers do.
When the buyer receives the inspection report, they can ask the seller to make repairs before closing. Or, they could ask the seller to lower the contract price in anticipation of having to pay for the repairs after the sale is finalized.
And most importantly, if the inspection period (usually the first week or two after a contract is signed) hasn't ended yet, the buyer can choose to back out of the contract if the inspection report revealed unforeseen problems they aren't willing to deal with.
It's also worth mentioning that an inspection can be a whole-home inspection or it can have a narrow focus. For example, if your inspector notices that the HVAC system isn't turning on, they might recommend that you order an HVAC inspection from a specialized professional.
Similarities between appraisals and inspections
It's not difficult to see why these two terms are often confused -- there are quite a few similarities between appraisals and inspections when it comes to real estate:
- Both involve a professional conducting a physical assessment of the property.
- Both typically occur shortly after a purchase contract is executed.
- Both are generally meant to protect the buyer, not the seller.
- The buyer generally pays for both, although the appraisal might be ordered and paid for by the lender and included in the buyer's "lender fee."
- Both result in reports that can potentially be used by the buyer to modify the contract.
The difference between appraisals and inspections
Although they are similar in the ways we just mentioned, there are a few important differences between appraisals and inspections. For one thing, the scope of the analysis is rather different. An inspection focuses exclusively on the property itself or a component of the property. In contrast, an appraisal takes the property's condition into account, but it also considers the location of the home, the characteristics of the lot it's built on, and the overall real estate market in the area.
In addition, a home inspection is far more thorough than an appraisal when it comes to the condition of the property. The appraiser just wants to get a general feel for the property -- how old are the appliances? When was the last renovation done? Are there any noticeable deferred maintenance items, is anything clearly broken, or are there signs of obvious damage -- like a hole in the wall?
On the other hand, a home inspector looks much closer at the details. They'll test every outlet, faucet, and appliance. They'll climb onto the roof to do a thorough assessment of its condition. They'll get into the attic to check for signs of concealed water damage. In all, an inspection usually takes several hours. An appraiser's time spent on the property itself is typically much shorter.
However, the most important difference between appraisals and inspections is simple. A real estate appraisal intends to assess the value of a property while an inspection is only concerned with the condition of a property.
The appraisal can be useful to the homeowner, but it is most often used by a lender to decide whether a particular property justifies the amount of money the borrower is requesting. In fact, unless you specifically order an appraisal for your own purposes, an appraisal is typically requested by, and used to protect, the lender.
On the other hand, the inspection is typically used by the borrower to determine what items need to be fixed by the seller before the deal is finalized, what defects they should plan to fix after closing, and the general condition of all of the components of the property.
Because they are typically intended for two different parties, most -- but not all -- real estate purchase transactions involve both an appraisal and an inspection.
Appraisals vs. Inspections
• Take the property's condition into account but also consider location, lot characteristics, and the area's overall real estate market.
• Are conducted relatively quickly.
• Mainly serve to protect the lender.
• Focus exclusively on the property itself or a component of the property.
• Are much more thorough, generally taking several hours.
• Mainly serve to protect the buyer.
The Millionacres bottom line
Let's be perfectly clear. When you go to buy a home -- whether it's going to be your primary residence, a second home, or an investment property -- you'll need both an appraisal and an inspection report in virtually all cases.
Even if you're paying cash, an appraisal can let you know that you're not paying an excessive amount of money for the home relative to other sales in your local market. And unless you're planning to immediately tear down the building after you close, an inspection is a valuable way to protect yourself and to know exactly what you're getting into.
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