Low inventory and rapidly rising home prices in many areas have complicated the appraisal process, causing some buyers and sellers to scramble.
Appraisals have always been an important part of the homebuying process but have often been considered a behind-the-scenes formality. Today, however, appraisals are a front-and-center issue.
A lender orders an appraisal during the mortgage-approval process to confirm that the loan they issue will be sufficiently supported by the underlying collateral, i.e. the home. The appraiser creates a report for the lender that compares the subject property to other recently sold properties – or “comps.”
That’s easy enough when there’s an abundance of sales data, but the low number of ready homes for sale in many areas has resulted in a lack of recent comps. Fierce buyer competition has also driven prices higher, meaning yesterday’s sales often closed at prices significantly lower than today’s prices.
So, whether you’re buying or selling, here are a few things you need to know about appraisals.
For Sellers
- Armed with Data: A good listing agent will be prepared heading into the appraisal process. They will know what comps an appraiser is most likely to use and be ready to furnish any off-market sales or very recent sales that can help make the case for a certain price.
- Appraisal Gap Clause: If you’re selling in a low-supply/high-demand area, it’s a good idea to include this contract clause, which stipulates that a buyer will move forward with the purchase even if the home doesn’t appraise at full value.
- Contract Terms: It’s important for a seller to look at contract terms beyond offer price, such as down payment amount. A higher down payment will generally cure most issues arising from a low appraisal.
For Buyers
- Play Your Hand: Low appraisals used to be an automatic invitation to renegotiate. In a highly competitive market, that strategy is likely to backfire. The onus may be on you, the buyer, to find a workable solution, or the seller may move onto the next offer.
- Broker Cooperation: Similar to the first point above for sellers, a buyer’s agent is also welcome to share comps or information with the listing agent if they think it will help result in a successful appraisal. However, note that buyers and their agents almost never directly interact with an appraiser working on behalf of a lender.
- LTV & PMI – Just because a home doesn’t appraise at the contract price doesn’t mean the bank won’t issue a loan or that the buyer must bring additional funds to the closing table. However, a low appraisal will increase the loan-to-value (LTV) ratio of the mortgage. In that case, a buyer putting down less than 20% may have to pay a higher private mortgage insurance (PMI) premium.
Appraisals are just one of the complexities that buyers and sellers must consider amid today’s unique market environment. Anticipating issues that may arise and working with your agent to come up with a plan to address them will help you complete your transaction successfully and with relative ease.
