When buyers and sellers come to an agreement on the price of a home, it’s the end result of the lowest the seller is willing to accept and the highest the buyer is willing to pay. During negotiations the offer and counteroffer can go back and forth until an agreed upon price is reached…or not. That’s the true market value at work. When you first work with your real estate agent and go over the list of things you want in a home such as how many bedrooms and baths or the school system or the commute to your work, you’re provided with a list of homes that meet your criteria. Working with your loan officer you also get your preapproval letter in your hand, knowing how much you want to borrow and what your monthly payments will be. Your preapproval letter essentially means your financing is all lined up and all that’s missing is a property address.
Sometimes, and this is often the case with first time buyers, the “perfect” home comes on the market and has everything the buyers are looking for. In their eagerness to get the home and be the lucky bidder, they might make an offer that’s over and above the asking price. And while the sellers are happy to take that offer, there might be an issue with the appraised value.
When an appraiser accepts an order to appraise a property, a copy of the sales contract is provided. In the instance of a refinance application, the home owners list what they feel the property is worth directly on the loan application. But this is only the starting point for the real estate agent. Upon receiving an appraisal order, the appraiser will first do a bit of homework, researching public records regarding the sales prices of similar homes in the neighborhood that have recently sold. The appraiser will look at three to four homes and select the best ones that are most like the subject property. Then, the appraiser comes up with a price-per-square-foot value and proceeds to make certain adjustments.
Very rarely are two homes exactly alike in the same neighborhood. They might look similar but there are differences, some small and some not so small, between then. One might have a bigger lot or one might have more trees or a swimming pool. Maybe there’s a three car garage instead of a two car garage. Inside, one house might have an upgraded kitchen or recent master bath remodel. Someone could have added an extra bedroom and added more square footage to the house. The condition of the homes will also be noted and the appraiser can make adjustments for that, too.
When appraising a property for a purchase, it’s common for the sales price on the contract to match the appraised value. After all, everything being equal, it’s an agreed upon price which in turn reflects current market values. But sometimes they don’t match. Sometimes the appraised property value is higher than what appears on the sales contract and sometimes the property is appraised at a lower value. During the course of a refinance when the value comes in higher, it can mean a slightly better interest rate if the loan program being selected is priced partly on the loan amount compared to the property value. Lenders refer to this as a “loan level pricing adjustment.” Or, in the instance of a cash out refinance, a higher appraised value can mean more cash to the buyers at closing.
In a purchase transaction, a higher appraised value doesn’t have much of an impact. When evaluating a loan application lenders will use the lower of the appraised value or sales price. This means when the value comes in higher than the contract price the buyers can’t automatically use that newly found equity as part of their down payment. All it says is that the buyers probably got a better deal than they thought as their accepted offer was lower than what similar homes have recently sold for in the area. In the instance of the appraised value coming in lower than the offer, then the impact is greater.
Let’s say someone makes an offer on a home for $200,000. The appraisal is ordered and after a few days is returned to the lender. The value according to the appraisal is $190,000, not $200,000. What happens? Because the lender uses the lower of the sales price or appraised value, the loan basis is on $190,000. This means the buyers must come to the closing table with the additional $10,000 difference. Or, the buyers can go back to the sellers and renegotiate the price. Most sales contracts today have an addendum that allows the buyers to back out of the deal if the property doesn’t appraise at contract price without penalty and get their earnest money deposit back. If the sellers decide not to renegotiate, the deal is cancelled and the buyers start looking for another home.
When an appraisal comes in high it can indicate a rather robust real estate market and when it comes in low it can indicate a faltering one. Either way, the lower of the two values is used when processing a new loan application. Again, lower or higher values are the exception in most markets and not the rule. Yet by working closely with an experienced real estate agent who knows the market well, your offer will likely be spot on.