 Personal Finance PowerPoint Presentation, Home Appraisal. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia, what you should know about home appraisals, which you can find online, looking up the references and resources, continuing your research from there. This is by Amy Fontinier, updated November 15, 2021, what you should know about home appraisals. Whether you're buying a home using a mortgage, refinancing your existing mortgage, or selling your home to anyone other than an old cash buyer, a home appraisal is a key component of the transaction. So typically when we have real estate transactions, say for example, you're purchasing a home, usually you can't put all the cash down for the purchase of the home. Typically you're going to need some kind of financing. That's when the loan comes into play, when the bank or financial institution or lender comes into play, and typically they're going to want to have the home as collateral in the event that you don't pay back the loan. So they have a recourse on the home, and in order to feel good about that, they have to have basically a value of the home and have an idea of what the value of the home so they can compare the risk on the loan with it. So if you're a buyer, owner, or seller, you'll want to understand how the appraisal process works and how an appraiser determines a home's value. What is an appraisal? An appraisal is an unbiased professional opinion of a home's value. Appraisals are almost always used in purchase and sales transactions and commonly in refinance transactions as well. In a purchase and sale transaction, an appraisal is used to determine whether the home's contract price is appropriate given the home's condition, location, and features. So clearly you would think typically if there's going to be a non-related buyer and seller, the negotiated price between the two of them will have a market price because you have two people interacting, hopefully with all the information necessary in order to make that interaction who have desires that are contrary to each other, and that's kind of how the market works. But obviously, as the lender is in place here, in particular, want to make sure that this is like a legit transaction. Obviously, you can imagine situations where something isn't kind of an arm's length transaction or one side of the transaction doesn't know all the information and therefore cannot make the appropriate decision or you've got family kind of situations involved, in which case it's not like an arm's length transactions as they say or typical market transactions with two people that are not related within the transaction. In a refinanced transaction, an appraisal assures the lender that it isn't handing the borrower more money than the home is worth. So if you're refinancing, then you're not really looking at the two individuals, you're looking at the, in other words, a buyer and a seller, you're looking at the person who owns the home and the other individual or entity being the bank or financial institution or the lender. Obviously, the lender is once again concerned that if they're going to be lending money that they have a good safeguard in the home itself in the event that the loan isn't paid back. Clearly, the bank does not want to loan more money than the value of the home and typically they want a nice cushion, possibly like a 20% cushion, so that you are solidly invested in the home and do not have the incentive to walk away from the home if the home was to go down in value and the loan was higher than the home value that puts incentives on people to say, why am I sticking around here and there's less incentive and the bank could get stuck with a home that has a value that is less than the loan amount which makes it difficult to be able to sell and recoup and so on. So lenders want to make sure that homeowners are not over-borrowing for a property because the home serves as collateral for the mortgage, so they want recourse, they want to be able to, if you default on the home, be able to foreclose on it. Now remember the relationship here, that doesn't mean, I always have to point this out because it's common kind of language for people to say, well, the bank owns 80% of my home and that's not really true, that's kind of an overstatement, it's an exaggeration, it's meant to be like funny, I think when you first kind of started, I own a home but the bank owns 80% of it but that's not really the case, right? You own the home and you took out a loan to finance the home which is equal to, you know, you could say 80% of the home. That's different though because you got the home on the books as an asset and then you got the liability on the books as the loan, as the liability. The net is the net values, that's the net effect on assets minus liabilities but it's not like the bank again, can't really do what it would be able to do if they actually owned 80% of the home. They can't tell you, hey, your driveway, would you mow the lawn or something like that? They can't tell you to replant a garden in your front window or something, they would like daisies and they can't tell you to do any of that kind of stuff because they don't own the home, they only have recourse on the home in the event that you don't pay back the loan. So if you don't pay back the loan, that's when they have recourse on the loan in the amount of foreclosure. In that event, then they want to make sure that the home's value is worth at least as much as the home as the loan amount so that they can sell the home, they can go through the costs of doing so and pay off the loan. They don't want to do that because they're not in the business of selling homes during the business of making interest but they want the security, it's just like anything else. We have the capacity to come out and do this even if it's like the nuclear threat, right? We want to be able to say that we can do this in the event that you foreclose and we'll do it, we'll do it but we really don't want to, right? That's one way to look at it in any case. So if the borrower should default on the mortgage and go into foreclosure, the lender will sell the home and recoup the money it lent. So that's what they're going to do in the worst case kind of scenario if they have to do that. So the appraisals helps the bank protect itself against lending more than it might be able to recover in this worst case scenario. So again, that's worst case scenario, not just for us as the home purchaser but for the bank too. They don't really want to go through the process of the foreclosure and the sale and whatnot. They just want to get paid their interest on the loan that they're going out. So the appraisal process and how values are determined because the appraisal primarily protects the lender's interest, the lender will usually order the appraisal. So clearly the lender is the one that's concerned here so they're going to want an appraisal that they trust. They then will likely be the ones that are going to be determining who's going to be doing the appraisal and so on and so forth. So an appraisal costs several hundred dollars and the borrower generally pays the fee. According to the appraisal institute and association of professional real estate appraisers, a qualified appraiser should be licensed or certified as required in all states, all 50 states, and be familiar with the local area. Per federal regulations, the appraiser must be imported, must be impartial and have no direct or indirect interest in the transaction. So clearly if the appraiser is actually getting, has a financial interest in the outcome of their appraisal, they at least look impartial. They look like they might be biased and may actually be biased. Clearly the point of the appraisal is to have an independent third person that both parties hopefully can trust to make an accurate appraisal process. So a property's appraisal value is influenced by the recent sale of similar properties and by current market trends. So note that the appraisal is far from perfect because you know you can have different people making the appraisal pretty different conclusions depending on the circumstances. And there's also a whole lot of different kind of techniques that you could use for appraisals although those techniques will be more standardized depending on the type of appraisal that is being put in place. But notice that every property is unique. The piece of land is unique. It's a unique location. The home itself, although it might be a track home or something like that, similar is still unique and therefore all you can do is kind of compare to other sales that took place which happened at different times because the point in time that we're going to sell this particular property is once again unique. And so you're comparing that to other properties that sold at a similar kind of time. So you take all that into consideration and you're seeing that the appraisal is a pretty big estimate. It's just going to be an estimate. You don't know what the market value is. What does the market value mean? It means that's what it sells for in a market. How do you know what that is? You sell it. But how do you know what it is without selling it? Well, it's kind of hard to do that. You got to kind of make an appraisal an estimate which is very estimatory. So the home's amenities, the number of bedrooms and bathrooms, the floor plans, functionality and the square footage are also key factors in assessing the home's value. The appraiser must perform a complete visual inspection of the interior and exterior. Note any conditions that adversely affect the property's value such as needed repairs. What is an appraisal report? So we got the report here. Typically appraisers use the uniform residential appraisal report from Fannie Mae for single family homes. This helps for some kind of standardization as well. So notice there's pros and cons to kind of standardizations for these kinds of things. Clearly, if it wasn't as standardized, then you know, different companies might provide more or less in terms of their appraisals and you can find different appraisals that have better and whatnot. But when you standardize the reports, then you can kind of do a side-by-side comparison between what one company does to another in a more standard fashion, which is nice. So the report asks the appraiser to describe the interior and exterior of the property, the neighborhood, and nearby comparable sales. The appraiser then provides an analysis and conclusion about the property's value based on their observations. The appraisal report must include a street map showing the appraiser's praised property and comparable sales used. So they're going to give you an idea. This is the location. These are the other homes that we used for the comparable sales. And you can look at it and say, well, how comparable is that? How close is that? How close in time was that sale actually made and so on. An exterior building sketch, an explanation of how the square footage was calculated. Photographs of the homes front, back, and street scene, front exterior photographs of each comparable property used, other pertinent information, such as market sales data, public land records, and public tax records that the appraiser requires to determine the property's fair market value. What home buyers need to know about appraisals. When you're buying a home and are under contract, the appraisal will be one of the first steps in the closing process. If the appraisal comes in at or above the contract price, the transaction proceeds as planned. If the appraisal comes in below the contract price, however, it can delay or derail the transaction. Chances are that neither you nor the seller wants the transactions to fall through. So as the buyer, you have an advantage in that a low appraisal can serve as a negotiating tool to convince the seller to lower the price. So clearly if you do the appraisal, you've got the set price that you're determined and the appraisal falls in low, then you would think that would be a tool in terms of the buyer's side of things to say, hey, maybe we should lower the price on this thing. So the bank won't lend you or any other prospective buyer more than the home is worth. So clearly that's the key on the bank's side of things. The bank is saying, hey look, I want the appraiser to determine what the appraisal value is and I want that collateral to be in place because that's going to be safeguarding our investments here. So though appraisals help buyers avoid overpaying for homes, a seller may feel that a low appraisal is inaccurate and be reluctant to drop the price. So you might find the lower appraisal and the seller is saying, well yeah, that appraisal is wrong because they're using a standard kind of technique and again, every home is kind of is unique so the circumstances in the economy might have changed drastically over the last year or something like that and the other homes that they're sold in the area that they're based on, maybe they were sold last year and it's totally different now or something like that. So if a bad appraisal is standing between you and your home purchase or sale looking to getting a second opinion via another appraisal by a different person, appraisers can make mistakes or have imperfect information and appraisals can be affected by bias. You can also try presenting a factual case for a higher value to the original appraiser. They may agree with you and revise the evaluation. So you might then, what's the key there? What's the next step? You could say, well, I mean, if you were to say, hey, your appraisal is low, you probably have an opinion about that. Like how is it low? Why was it low? You might want to look at their calculations and say, well, what did they base this on to come up with a number that isn't what I believe it's going to be. You might talk to that particular appraisal and say, hey, look, you took up this property, that property, and that property, they were sold before this condition happened in this real estate market and there's kind of like big changes happening here, you know, and whatnot. Or you might look into another appraisal for a second opinion, obviously. So what home sellers need to know about appraisals is a seller a low appraisal if accurate means you may have to lower your home's price to get it sold. So if the appraiser comes in at a lower price, then that's going to have an impact on the seller. That's not good news for the sellers type of thing if they want to sell it at the higher price. So holding out for an all cash buyer who doesn't require an appraisal as a condition of completing the transaction is unlikely to net you a higher sales price. So you have to overpay for a home. So one method is to just avoid the appraisal process and the bank all together by finding someone that just wants to pay cash. But you'd have to find someone that wants to pay cash and is willing to pay cash over the appraisal value which is kind of a lot to ask. Unfortunately, if you're surrounded, if your surrounding area has experienced a recent distressed sales that can lower your home's appraisal value. So if you feel that your home's value has been dragged down by the sales price of nearby foreclosures and short sales, you may be able to convince the appraiser that your home is worth more if it's in significantly better condition than those properties. So they might be basing their appraisal on these properties that sold around you. But possibly those properties were sold under some kind of duress. Possibly, possibly they were sold because the person needed to leave town and they sold the home for a low price or something like that or there was a foreclosure and whatnot which could significantly lower the value of the home. And again, the appraisal is going to be based on usually the homes that were sold recently in that area. What refinancing homeowners need to know about the appraisals? If you're refinancing a conventional mortgage, a low appraisal can prevent you from doing so. So the home needs to appraise at or above the amount you want to refinance your loan to be approved. So if you're refinancing, now it's just between you and the lender. You're trying to get more money from the lender. The lender's not going to give you more money than the home is worth, meaning whatever the gap is in equity is kind of the playing field. And to know the gap in equity, meaning the difference between the loan value and the home value, you got to know what the home value is at any given time and the bank's going to want their own assurity on that end, typically. However, if your existing mortgage is an FHA mortgage, you can refinance without an appraisal through the FHA Streamline program, a great option for underwater homeowners. So how long does a home appraisal take? The appraisal process takes an average of seven to 10 days. The appraiser visits the property and spends an hour or two inspecting the home's interior, exterior, measures the square footage and evaluating the home's features and fixtures. The appraiser also compares the home to other similar recently sold homes in the neighborhood, a.k.a. the comps. After doing the physical inspection and running the comps, the appraiser writes an appraisal report. The amount of time it takes for the entire process depends on the complexity of the appraisal and the appraiser's workload or schedule. What does a home appraisal cost? Home appraisals typically cost between $300 and $450, the home location size and condition factor into the cost. Appraisers should work on a flat fee or hourly basis if the appraiser expects to be paid a percentage of the home's value. It can signal an unethical practice which should be avoided. So obviously, again, they're trying to be independent. So if they're going to get paid based on the square footage that they do, then it looks like they might have an incentive to have an opinion one way or the other. So you would think that they would have some kind of a flatter rate kind of structure so they don't look to be unindependent, which would damage the value of the whole process of them trying to be a third-party appraisal that's not involved in the process. So what happens after the appraisal? After the home appraisal is completed, the next step is mortgage underwriting. The underwriter reviews the loan file to make sure everything is in order and that all the required documents have been submitted. The underwriter then assesses the risk associated with the loan and either denies or approves the loan based on all the information. What lowers a home appraisal? The home's location has the biggest impact on the valuation. Do I have to say it? Do I have to say it? You know the three words I'm going to say. They're all the same one. They're all the same word. Location, location. Okay, I won't say the last one, but you know what the last one is too. So for example, the value will be negatively impacted if the home is in an undesirable neighborhood or situated next to a junkyard, power lines, or busy street. So no one likes to be having their home next to the junkyard unless there's some good junk in that yard that you might be able to do stuff with. Like if you're a junkyard artist or something. But in the case, though you can't change the property's location, you can do something about other factors that could lower the home appraisals. For instance, you can spruce up your curb appeal by making sure the house is clean and tidy and take care of any light repairs and routine maintenance items. So you can make your house look quite clean and tidy in comparison to the junkyard next door. So in the case you can fix up the house obviously to make it look nice would be good. The bottom line. So when everything goes smoothly, the home appraisal is just another box to check on a closing checklist. So hopefully it's just another process, right? I'm going through the appraisal process if it's part of the home purchasing process and the bank needs to check this one off. And so you would expect that it would be checked off. You're hoping the appraisal is somewhere around the purchase price that you have because that would indicate that you would think that you have a fairly accurate market price that you're dealing with. You check it off. The bank's happy. You move forward with the sale. But if there's something that happens, then obviously you take it from that point. When the appraisal value is lower than expected, the transaction can be delayed or even canceled. Regardless of which situation you encounter in your home buying, selling, or refinance experience, a basic understanding of how the appraisal process functions can only work in your favor, especially if you're buying for your first home.