An appraisal is a process of determining the value of the home by a professional who is unbiased and impartial in their judgment. Appraisals are used in home purchase transactions & mortgage refinancing as they are useful for all parties involved in a real estate transaction from the home buyer & seller to the lender. In home purchases, an appraisal is helpful to ensure the home selling price is an accurate representation of the home’s condition, surrounding location, and neighbourhood. Whereas, in a refinance, an appraisal is essential for the lender to determine the amount of funds that can be borrowed.
In each case, the appraisal helps the lender ensure that the homeowner is not borrowing more than what the home is worth. The home acts as the collateral in the transaction, such that if the borrower were ever to default, the lender can seize and foreclose on the home or conduct a power of sale on the home. If the value of the home is less than the amount borrowed, then the lender is taking on a large amount of risk and can lose money on the transaction.
An appraisal can cost anywhere between $300 - $600 and is usually part of the closing costs of the transaction. There are several factors that can impact the value of your home:
The appraisal takes place right after the buyer and seller have agreed on a price and an agreement has been signed. After all the details regarding the agreement have been finalized, the lender will send an appraiser to determine the value of the home.
However, the seller can also choose to get an appraisal done before the buyers approach them in a pre-listing appraisal. In this case, the appraisal is done before all the negotiations and it removes any unpredictability of a lower appraisal after an agreement has been signed. The pre-listing appraisal home price can stay the same all the way till closing as that is the fair market value of the home. A pre-listing appraisal should be used when:
An appraisal is an essential part of the home buying process and will be one of the first to take place in the closing process. There are two situations that can take place, the appraised value is greater than the contract price and the transaction can take place as the buyer and lender will be satisfied with the outcome. However, if the appraised value is less than the contract price, the transaction will be delayed till the borrowing amount is sorted out which can delay the transaction.
As a buyer, if the appraised value is less than the listing or contract price, you can use it as a bargaining chip to try to reduce the price. During the negotiations, this can be a useful tool to reduce the price. However, the bank will not lend you an amount greater than the appraised value of the home. A lower appraisal can be a great tool for buyers, however, the seller may not agree to lower the price or might choose to get a second opinion.
A home appraisal can be useful to determine the list price for sellers. However, if the appraisal is done afterward and the appraised value is less than the list price, sellers might need to reduce the price or get another appraisal. Sellers can also choose to wait for an all-cash deal where an appraisal is not required, but that is difficult and can prolong the selling process. If the location your house is located in has experienced distressed sales resulting in a greater number of homes for sale, it is likely to drive your home price down too.
If you are getting your mortgage refinanced, an appraisal lower than the outstanding mortgage amount can prevent you from getting the new mortgage. The reason is that lenders use the home as collateral If the home is valued at less than the outstanding balance, the risk for the lender is too high. You may also need a home appraisal if you are receiving a reverse mortgage in Canada.
There are several ways in which you can get a higher and accurate appraisal for your home:
There are three reasons for the appraised value being less than the quoted price:
In most cases, the seller is trying to maximise their gain from the transaction and increases the price well beyond the fair market value in the hope that a buyer might take up the deal. In a seller’s market where there are excess buyers and fewer homes, sellers take advantage of this scarcity and drive up prices well beyond the fair market value. Seller’s also sometimes overestimate how much their house is worth and this can be problematic, hence, it is best to use an agent who can give an impartial starting price for the house.
An appraiser does a deep dive into the home from the exterior roof shingles to the interior piping. Homeowners might not even be aware that there is something wrong with their homes. The appraiser can also find issues that might not have occurred to the seller such as an additional room that does not have the necessary permit. This can result in a ‘cost to cure’ cost which reduces the value of the home. These factors can lead to the appraised value coming well below the contract price.
There can also be the rare situation where you get an inexperienced appraiser who does not have the necessary tools or comps to make an accurate judgment. If the appraiser has not dealt with similar homes or if they haven’t worked in that location for a period, then they can make mistakes too. Hence, if the appraiser comes well below the contract price, be sure to ask questions yourself, do research on comparables in the area, and worst case, get another appraiser to value the home.