Home appraisals are a crucial part of the home buying process, but can also throw you for a loop in certain situations. By far the number one complaint against lenders is faulty appraisals. Home appraisals are always requested by a lender to make sure that the amount of money a buyer is borrowing is fitting to the fair market value of the home. However, a faulty appraisal can make or break a loan and your mortgage interest rate is directly dependent on your appraised value.
Wondering what causes a low home appraisal and what you can do about it? Here are some tips.
How Home Appraisal Values Work
The home appraiser focuses on comparables. Comparables (comps) are houses in the same market that most closely match the house you are buying or selling. Depending on the market, an appraiser may use 3-9 comps, or possibly more. Home appraisers typically choose homes that are geographically close (generally within 1 mile), sold recently (generally within the last 6 months), and similar in style and features. The house is inspected, compared to other homes, adjustments are made based on differences in the homes, and a report is produced.
You may receive a low home appraisal if other comparable homes in your market were sold in a distressed manner, if the overall market is dropping, or because of skewed data.
If a you receive a low home appraissal, there are four possible outcomes:
- Your mortgage interest rate will have to be recalculated based on the appraised value and the new loan-to-value (LTV) that results from it
- A new, lower home purchase price is negotiated
- The buyer increases their down payment to meet LTV and down payment minimums
- Buyer backs out of the home purchase
- An appraisal reconsideration request is made to the appraiser by the lender
Effects of Low Home Appraisal Price On a Purchase
A low home appraisal may significantly affect the home purchase. Because your LTV is a factor of the lower of the appraised value or the purchase price, you’ll need to take action in order to avoid losing your mortgage interest rate and possibly having the purchase fall apart. (note: interest rates are in large part determined by your LTV)
Renegotiation of Purchase Price or Increase Down Payment to Keep LTV
If you are closing with a seller, you want the home appraisal price to be at or above the agreed upon purchase price. If the there is a low home appraisal, you do not necessarily want to challenge that appraisal with another appraisal. If you can convince the seller that the low appraisal is accurate, you may be able to negotiate for a lower price on the home.
If the seller is unwilling to negotiate, you will have to either come up with the cash difference, or back out of the deal. It is fairly unlikely that the seller will be unwilling to negotiate, as all other buyers will see the low appraisal and make low offers. Because of this, it is smart to make a new offer that may be at appraisal price or slightly above. The seller would be smart to compromise.
Effects of Low Home Appraisal On a Refinance
Reduced Loan Amount to Keep LTV
For the sake of easy math, consider a home that has an expected value of $100,000. Say you are approved for 80% LTV ratio, so you are approved for a home loan that covers $80,000 of the home. Your down payment would have to cover the other $20,000 of the home.
If the home is appraised below the expected value, at $90,000, the LTV ratio you were approved at would only cover $72,000 of the home. This means you will be expected to cover that extra $8,000 in your cash down payment.
Choose the Right Lender and Ask the Right Questions
Lenders generally have two methods of ordering appraisals. Some lenders employ their own panel of appraisers who have an ongoing flow of appraisals that they conduct for the lender. This usually offers better quality because the appraiser and lender communicate better and know each other better. However, many lenders outsource their appraisals to companies called Appraisal Management Companies (AMCs). This method uses a blind draw for the appraiser that will perform the work and the lender does not have any direct contact with the appraiser. This can cause faulty valuations because the AMCs tend to act as a buffer between the lender and appraiser so there is no relationship involved and the appraiser tends to ac more cautious and conservative.
Be sure to ask your lender is they employ their own appraiser panel OR if they use an AMC. This is something you should ask before you decide which lender you are going to use. Remember that your quoted interest rate is only as good as the appraisal is accurate.