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Appraisal Report for a Mortgage
The appraisal is one of the most important pieces of the mortgage puzzle and can make or break the entire transaction. The appraisal, ordered by the lender and provided by an independent third party called an appraiser, is a comprehensive analysis of the value of the home you are seeking to purchase or refinance. While you and the seller have agreed to a purchase price for the home you want to buy, the appraiser provides the lender with an objective assessment of the value of the property. If you are refinancing your mortgage, the appraisal is used to confirm that you have enough equity in your home to qualify for the loan amount you want.
The appraiser's valuation analysis is usually based on recent property sales in an area, known as comparables, current listings in the area, the condition of the neighborhood in which the property is located and other factors such as property square footage and amenities. The lender wants to make sure that that value of the house exceeds the value of the mortgage so that the lender can recover its money in the unfortunate case when the borrower cannot repay his or her mortgage.
While property amenities including a pool, deck, view, yard, hardwood floors, high-end finishes, alarm system, sounds system and other features may boost a property's value, appraisers usually rely on a price-per-square foot property valuation method based on nearby home sales. Although the appraiser performs his or her analysis independently it can be helpful to work with your real estate agent or online resources to provide a list of comparable sales in the area that support the property value you are seeking. Additionally, if any nearby homes sold for a relatively low price it can be useful to point out the differences between that home and the property you want to buy or refinance.
- Review our Example Appraisal Report
Perhaps most important, the appraisal report is used to confirm the loan-to-value (LTV) ratio for your mortgage. LTV is the ratio of the mortgage amount to the value of the property you are buying or refinancing and the lender uses the appraised fair market property value to calculate the ratio. If the appraised value of the property is less than expected, it could result in an LTV ratio that is above the lender's acceptable limit.
For example, if the lender's LTV ratio limit is 90% and you have agreed to buy home for $100,000 using a $90,000 mortgage but the property appraises for $95,000, the LTV ratio based on the appraised property value is 95% ($90,000 loan / $95,000 property value = 95%), which exceeds the lender's maximum LTV ratio. The same logic holds true when you are refinancing. If the property value appraises lower than expected you may not be able to complete your refinance or your loan amount may be lower than you want. When the appraised property value is less than the purchase price or expected value this is called the appraisal coming up short, which can cause significant issues. We address what to do if your appraisal comes up short below.
Although an appraisal report is different than a home inspection report, the appraiser may identify issues with the property when he or she conducts an on-site review. The appraiser usually documents significant structural issues such as an unstable foundation, failing roof, water damage, poor electrical wiring or faulty plumbing in the report provided to the lender. Depending on the severity of the issues, the lender may require you to fix the issue before you complete the property purchase or refinance. Addressing major structural issues can be costly and time-consuming and may also involve negotiations with the seller to have them pay for part or all of the repairs.
In addition to assessing the structural soundness, the appraiser also reviews the property zoning as well as any applicable permits. For example, if you are buying a multi-family home, the zoning for the area must allow that type of property. Or if there was a significant property addition, the appraiser usually confirms that the proper permits were pulled and that the addition is legal. If the appraiser uncovers zoning or permit issues it can delay the mortgage process, or in a worst case scenario, prevent your loan from being approved.
Although the borrower typically pays the appraisal fee (it is one of the closing costs listed on page two the Loan Estimate), the lender selects the appraiser. The appraisal fee generally costs $400 - $750 depending on the approximate value of the property. If you are working with a mortgage broker then the funding lender, the company the mortgage broker is using to lend you the money for your loan, not the broker, selects the appraiser.
One point to note is that the appraisal can be transferred to a different lender. So if you decide to change lenders in the middle of the mortgage process, after the appraisal report has been completed, then your new lender can use the existing appraisal. If you decide to transfer the appraisal report, the new lender reviews the appraisal and determines if they will accept it. Because the appraisal report was ordered by, and issued in the name of, the original lender, if the new lender agrees to use the existing appraisal report, the appraiser will likely be required to re-issue the report in the name of the new lender. Most appraisers charge a reduced fee ($100 - $200) to re-issue an appraisal report in the name of a new lender.
When the appraised value of the property is less than expected, this is known as the appraisal coming up short. If the appraisal report shows a value for the house significantly less than the price you have agreed to pay for it (or anticipated in the case of a refinance), then the loan-to-value (LTV) ratio may be pushed above the lender's maximum limit which may prevent your loan from being approved. There are several steps you can take if your appraisal comes up short:
- You can try to renegotiate and reduce the purchase price of the home, which the seller may be unwilling to do
- You can reduce your loan size by increasing your down payment so that the LTV is less than the lender's maximum limit, which you may not have the money to do
- If you do not have sufficient personal funds, you can apply for a second mortgage or a personal loan to pay for the higher down payment you are required to make, although your lender may not permit this. Please note that taking out a loan can negatively affect your debt-to-income ratio and credit score which can cause your mortgage to be declined so do not apply for any loan before you speak with your lender
- The lender may ask you to purchase private mortgage insurance (PMI). If your LTV ratio is above 80%, which may happen if the value of the property is less than expected, lenders typically require the borrower to purchase PMI which insures the lender against loss if the borrower does not pay back the mortgage. PMI typically requires borrowers to pay an ongoing monthly fee in addition to their mortgage payment.
- The lender may decide to decline the loan, in which case you are out the cost of the appraisal as well as a lot of time and effort
- You can also ask the lender to review the appraisal or request an additional appraisal report although there is no guarantee that the new appraisal report will produce a higher estimated property value, or if it does, the lender may not use the higher value for its underwriting process. The borrower is required to pay for the second appraisal
The best way to avoid having your appraisal come up short is to make sure you pay a fair price for the property and not overpay
You should work closely with your real estate agent and do your own research on property values to help you determine a fair price for the property you want to buy or refinance. This way you can avoid unnecessary complications in the mortgage process such as your appraisal coming up short.
Sources
"Appraisal Review Reminders." Freddie Mac Learning. Freddie Mac, November 2019. Web.
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