How Can an Appraisal Make (or Break) Your Loan?

If you’re buying a house, then like most people, you’ll need to get a mortgage. You talk to a few lenders, get some quotes, pick a lender, and apply for your loan. Your lender then starts the process of getting you approved. They ask you for documents, send out disclosures, and order an appraisal.

What Is an Appraisal? How Is It Different from Home Inspection?

An appraisal estimates the value of the home you are purchasing based on research into comparable homes (“comps”) that have sold within the past six months within a mile of your home. Sometimes, if there are no readily available comps within those parameters, appraisers will go outside that distance or time frame in order to come up with a value for your home.

Now that you know what an appraisal is, here’s what it’s not: an assessment of the structural soundness of your home. That’s something you would have a home inspector or structural engineer do. They normally inspect the house before you go to contract. This way, you’ll know if you need to renegotiate the purchase price based on the fact that you’ll have to replace the boiler or roof within a few years.

Back to the appraisal. Your lender has now ordered it, and they’ve asked you for the contact information of your realtor (or seller, if you’re not using a realtor).  At this point, you’re starting to get a little nervous about the whole appraisal thing. You know you qualify for the loan amount you’re requesting and you’re positive your credit is good, but what if you’re paying too much for the house? You tried to do your research on recent sales and what the house was worth. But your wife really loved this one and you kind of got carried away in the bidding process. 

Can You Order the Appraisal before Making an Offer?

The next day at work, a younger colleague asks how the mortgage approval is going, and you tell him your fears about the appraisal. He asks, “Why didn’t you order the appraisal before you made an offer? This way you’d know what it’s worth.” You mumble something about how your lender took care of it, but inside, you’re thinking, “Yeah, why didn’t I order an appraisal first?”

Here’s why — first, a full appraisal report requires interior access to the property. If you were the seller, and you wanted to sell your house for the highest possible amount, would you let in an appraiser who’s hired by your potential buyer? No way! They might come up with a low ball value.

The second reason is this — Appraisers aren’t there to tell you what your house is worth. There’s too much liability for them to do so. Their job is to research the market and support (or not support) the purchase price you agreed to pay for the house. You have set the market price for your house by negotiating with the seller, who accepted your offer. The appraiser just has to find comps that support that price. That’s why an appraiser needs a copy of the fully executed contract before they can finish up the report.

Who Chooses Your Home Appraiser?

So now you know why you can’t order an appraisal yourself.  But the next day, you run into a buddy at the gym. You tell him you’re buying a house, and he says, “My cousin’s an appraiser! You gotta use him.” You take his cousin’s number and promise to pass it on to your loan officer.

But your loan officer explains he can’t order it through him. Why not? Because the rules about appraisal ordering changed in response to the subprime mortgage meltdown. Before 2008, loan officers could order appraisals themselves and they often pressured appraisers to bring an appraisal in at the value, or else they wouldn’t use them anymore. As you can imagine, these appraisals were often inflated or at least not as objective as they should have been.

Now, loan officers are prohibited from ordering appraisals, and lenders must order them through an appraisal management company or “AMC”. The AMC then randomly places the order with a licensed appraiser. 

After he finishes explaining this, your loan officer can tell that you’re nervous. He says he should have the appraisal report back within a few days.

Can You Still Buy the Property if the Appraisal Comes in Low?

Since this is your first time buying, you ask him what happens if the appraisal comes in low. You’re paying $400,000 for the house and getting a loan for 90% or $360,000. Even if the appraisal value comes in below $400,000, you can still buy the house, right?

Your loan officer is silent. Then he says, “Banks lend off the lower of purchase price or appraised value.” Which means that if the house appraises for $390,000, the bank would only lend you 90% of $390,000 or $351,000. But you signed a contract agreeing to pay $400,000 for the house. So you would have to come up with the difference or $49,000 (instead of $40,000 as you had originally planned).  Your loan officer tells you that if it comes in low, you have other options — you can either renegotiate the price or get out of the deal and get your deposit back.

But you really want this house.  A few days later, you get an email from your bank: your loan is approved! The appraisal came in at the $400,000. In a few weeks, you will be the proud owner of a beautiful new home!

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