What is a Home Appraisal & Tips for Low Appraisals

We’ve all heard of appraisals, but what are they, and how do they work? Let’s dig into appraisals to understand what they are and how they can potentially alter the trajectory of a real estate transaction.

In its most basic form, an appraisal is an expert assessment and estimate of the value of a particular property. Lenders need to know that the money they are putting into a home purchase is safe. They do this by testing the borrower’s creditworthiness and ensuring that the borrower is buying the home at a fair market value to protect the bank’s money.

Buyers, lenders, and sellers are all affected by the outcome of an appraisal, which is why real estate appraisers in all states are licensed or otherwise certified to do their work.

Overall real estate market trends can influence appraisals and alter outcomes of a real estate transaction, especially in highly competitive markets. Below we highlight the key things you’ll need to know about the appraisal process.

What is a home appraisal?

A home appraisal is an assessment of a property’s current market value, and there are several ways that appraisers can determine a home’s value. 

Market conditions and the amount of comparable sales an appraiser can look to for value estimation dictate what tools they use to reach a value. That said, the basic approach compares the subject property to similar homes within proximity. Bedroom and bathroom counts, square footage, and condition of the properties all factor into the calculus. Similar properties are referred to as comparables or comps.

Depending on where you plan to purchase a home and the market density, some comps may be readily available while others may be difficult to find. 

Imagine a high rise condo building where the "C" line units are similar from floors 3-18. If that’s the case and you are purchasing unit 15C now, and unit 16C just sold two months ago. That will be viewed by an appraiser as a more relevant comparable sale. 

Conversely, there will likely be fewer data points of comparable sales in a rural or suburban setting, making the appraiser’s job a little more complicated. 

Let’s assume a buyer and seller agree on a price and terms for buying a home and execute a purchase agreement. Assuming the buyer is financing some portion of the transaction, the lender will order an appraisal. An impartial third-party licensed appraiser will then visit the property to walk through it, take photographs and measurements, and then research recent sales in the area to arrive at a value. 

The appraiser will publish their appraisal report and deliver it to the bank. More often than not, the appraisal will affirm the purchase price that the buyer and seller agreed on. Sometimes, however, the assessment will be high and other times low, but we will go into low appraisals below. 

If the appraisal comes in at the contract number or above, the lender is satisfied, and the deal progresses. 

Why do I need an appraisal?

If you’re putting 20% down on a property and financing 80%, the bank has more money at risk than you do! While their position is debt and yours is equity, and they come with different risk profiles, the lender has more money in the deal than you do. Hence they will mandate an appraisal, and they will also require title insurance. 

The basic premise of why lenders require an appraisal is to protect the lender’s capital. If we hearken back to the Great Financial Crisis, cheap credit and loose lending guidelines fueled a massive housing bubble. When the bubble burst, banks were stuck with trillions of dollars of underwater loans. Banks have since tightened lending, and appraisals have taken a front and center role in protecting lenders’ capital.

Even if you only finance a small portion of the purchase price, the bank will require an appraisal. Unless you are paying cash for the property, the appraisal will be germane to the transaction.

Should I get an appraisal when paying all-cash? 

If you are not financing any portion of the purchase, it’s not required to get an appraisal, but you may wish to order one. It could be helpful as a sanity check to make sure you’re not overpaying for a property. 

If you’re paying all cash, appraisals are not required, but they can be a good idea as it tells you if you are paying a fair market value for the property. You and your real estate professional could also negotiate with the seller to make the terms of the deal dependent on an appraisal. 

For example, say you were under agreement to purchase the property for $500,000, but the appraisal comes in low at $475,000. The buyer and seller would then renegotiate the purchase price. Of course, anything is negotiable if all parties agree.

Conversely, if the property appraises at $525,000, the seller may want to renegotiate the purchase price to $525,000, so make sure to structure your appraisal contingency agreement appropriately. 

Who pays for the home appraisal?

Buyers pay for the appraisal fee. Depending on the region, the cost of a home appraisal can vary between $300 to $600. In major cities with high living costs, appraisal costs may creep up to $800 or even more!

How do buyers and sellers prepare for an appraisal? 

Your buyer’s agent and the listing agent need to have recent comps available that substantiate the purchase price you are offering for the property. And comps are just that -- comparable properties within very close proximity to the subject property you’re purchasing. Timing is crucial as the comps must be as recent as possible. Further, bedroom counts must be similar unless there are no comps with identical bedroom counts. 

It will be most beneficial for your agent and the listing agent to provide as much data to the residential appraiser as possible to facilitate their job. The appraiser will be grateful for the front-loaded research assistance. 

This way, the appraiser can come into the property, take a look around, snap some photos and then review the comps your agent or the listing agent have prepared for them. While this will not guarantee that they will agree with the price on the sale agreement, it will make their job easier and ensure that they see the best comps you can find that maybe they would have otherwise missed.

It will be equally valuable if a seller can clean the home and declutter it to look its best and shine for the appraiser. It helps when they put pen to paper and dig into the data to arrive at an assessment of value. A clean home will also show that the property is cared for and may just be the extra consideration to help an appraiser arrive at the proper valuation.

Most sellers will have (or at least should have) done these items before listing the home, for these tips are crucial for selling a home at a maximal value. So it shouldn’t be too difficult for them to clean up in anticipation of the appraisal. 

What if my home doesn’t appraise for the purchase price?

If a single family home appraises lower than the purchase price, this is where the rubber meets the road. If the appraisal affirms the purchase price or comes in higher, it justifies the value for the mortgage lender, and then the deal continues along. 

If the appraisal is low, there are some complications and potential legal ramifications. Lenders generally calculate the borrower’s loan-to-value (LTV) based on the lesser of the sales price or the appraised value. If a property appraises low, a borrower either funds the difference in additional cash towards the down payment or uses a higher LTV if the bank allows. 

A third option is to negotiate with the seller. If the seller is unwilling to adjust the sales price to the appraised value and the borrower cannot increase the down payment amount, it could lead to a loan denial by the lender.

A low appraisal will have obvious and important consequences to the transaction, so best to check with your attorney and broker to impact your transaction, specifically any earnest deposit money, at risk.

Can I appeal a low appraisal?

In short, yes, your real estate agent should provide comps to the appraiser and appeal to them to reconsider their valuation. There is no guarantee that this will work. 

Other options may include requesting a second appraisal altogether. But this can only happen when using a broker and will add time to the transaction. If you are going through the process with a major lender or bank, they will be unlikely to "unsee" it once they see a low appraisal. 

However, a good mortgage broker can just take the file to a new lender and start over and order a new assessment. Again, this adds time, and a seller may not be willing to grant it, but it’s a potential option.

Tips for low home appraisals 

• Appeal the appraisal with the lender
• Request a second appraisal if the lender allows 
• Increase down payment to fill appraisal gap
• Negotiate a lower price with the seller

What about bidding war situations?  

In competitive markets rife with bidding wars where houses sell rapidly and often above asking prices, it is common for sellers to worry that their homes will not appraise. That worry is why sellers prefer cash deals or offers without mortgage financing contingencies. 

Some buyers will make their offer non-dependent on an appraisal, which essentially means that they will agree to fund any gap in the capital stack if required, which sellers love. Hence, borrowers with lots of liquid capital in the bank also help assuage sellers’ fears. Then the seller knows that a buyer can fund any potential shortfall if the appraisal is low.