The price at which a seller lists a home doesn't necessarily reflect its actual value. That's why a home appraisal is a crucial part of the buying process.
What is a home appraisal?
A home appraisal is a professional estimate of what a home is worth. Appraisals come into play when you’re looking to buy a home and finance it via a mortgage or when you’re looking to refinance a mortgage. The goal of a home appraisal is to determine how much a given property is actually worth.
Not only can a home appraisal protect you as a buyer, but it’s generally a mandatory step on the road to getting a mortgage.
When you’re buying a home, the appraisal process involves having a bank-approved property appraiser come out to inspect the property. The appraiser will do a thorough evaluation of the home, taking note of things like:
- square footage;
- lot size;
- curb appeal;
- number of bedrooms;
- number of bathrooms; and
- added features, like garages, fences, and swimming pools.
Once that information is noted, the appraiser will dig up comparable sales in the same neighborhood to determine the value of the home you're looking to buy.
For example, if the home you want has a purchase price of $200,000, the appraiser will find similar properties in the area that were bought recently. If those homes sold for between $190,000 and $210,000, you're in good shape. If not, you may be able to convince the buyer to take a lower sum.
Keep in mind that the appraisal process can be different for new construction homes. Comparable sales are often hard to come by with new construction, so appraisers generally take the estimated cost of the land that new home is built on coupled with the cost to rebuild that property to arrive at its value.
The home appraisal process is similar when you're looking to refinance an existing mortgage. In that case, the appraiser looks at your current space, taking note of things like upgrades and home improvements, and compare it to homes that recently sold in your neighborhood to assess its value. If your home appraises for a value that gives you at least 20% equity in it, you're generally good to go with that refinance.
A home appraisal isn't the same thing as a home inspection. The latter is a deep examination of the state of the home you’re looking to buy so that you’re not hit with costly surprises after the fact. A home appraiser’s job isn’t to look for potential problems; it’s to determine that property’s value.
Why do lenders require home appraisals?
Mortgage lenders insist on home appraisals because they want to protect themselves in the event you can't keep up with your payments. If the actual value of your home is less than the price you pay for it, or less than the value of your mortgage, your lender won't be able to sell it for a high enough price to recoup the loan if you default. As such, appraisals are generally a requirement you can’t get out of.
You’d think that because mortgage lenders require appraisals, they’d be the ones to pay for them. But not so. As a buyer, you’re the one responsible for covering an appraisal, and you’ll usually pay for it as part of your closing costs (costs that apply when you close on your home and sign your mortgage). Keep in mind that lenders generally have a list of approved appraisers they work with -- and whatever fees they charge get passed on to you.
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What happens if your home appraisal is too low?
Sometimes the sale price of the home you’re looking to buy will be higher than its appraised value. When this happens, you risk getting denied your mortgage in its initial amount; instead, you’ll generally be offered a mortgage that matches the home’s appraised value. When this happens, you have two options: You can cover the difference yourself by making a larger down payment or you can try negotiating with your seller to lower the home’s price. If neither option works, you may have to walk away.
That said, it is possible to contest a home appraisal. If your real estate agent feels that your bank’s appraiser is off, it may be worth your while to do some digging or even hire your own appraiser to submit an alternate analysis. But the latter will be on your own dime, so keep that in mind.
Though a home appraisal might seem like a nuisance, it can actually help protect you as a buyer. If a professional real estate appraiser determines that your home is worth much less than what you’re looking to buy it for, it could be a bargaining tool that lowers your purchase price. Or, it could serve as a red flag that you’re paying too much for that home. And that’s good information to have when you’re looking at such a major purchase.