What is an appraisal and how can it affect your home loan?

Female real estate agent and male inspecting house

After months of searching, you’ve finally found the perfect home and are already picturing your family relaxing in the den. The last thing you want is a problem during the loan process that derails your dream. Understanding the home-buying process is critical to making things go smoothly. One item you need to know is the home appraisal. What is a home appraisal, and how can it affect your home loan? Let’s dive in.

What is an appraisal?

When purchasing a home and applying for a mortgage, one of the first steps the lender will do is order an appraisal. The house will need to be evaluated by an independent, unbiased professional appraiser to estimate the home’s current market value. A home appraisal is an expert’s opinion of the value of a given property.

How is an appraisal based?

The value of a home is based on its general condition, age, location, and size. The number of bedrooms and bathrooms, plus any structural improvements, like remodeled rooms or additions, are critical factors. Amenities are another consideration—is there a swimming pool on the property or a boat dock? Features such as hardwood floors or majestic views also influence value.

The purchase price of comparable properties within a given radius is a crucial component. These prices demonstrate what the market is willing to pay for a home similar to the one being appraised and generally carries the most weight.

Because the home will be used as collateral for the mortgage loan, the lender needs to be assured that the money loaned doesn’t exceed the home’s value, should the buyer default. The lender will typically order the appraisal, but the appraisal cost is paid by the buyer (generally between $300-$400).

The appraiser will visit the home and visually inspect the interior and exterior. They’ll take measurements and note any conditions that might positively or adversely affect the property value. The appraiser will also research recent home sales in the areas and deliver a final appraisal report that includes an opinion of value.

What if the appraisal is lower than the sale price?

If the appraisal value is lower than the sale price, you’ve reached a fork in the road. The mortgage lender is unwilling to approve a loan for more money than the home is worth. You can use a low appraisal to encourage the seller to lower the home’s price, or you can choose to make a larger down payment. With a larger down payment, the amount you need to borrow will be less than the appraised value.

If you feel the appraiser understated the value, you could challenge the estimation or get a second opinion. Sometimes home values lower due to foreclosures or short sales in the area. You may convince your appraiser that this was the case with some of the comparable properties while at the same time, proving that your home is in significantly better condition than those that were sold at a discount.

What if the appraisal is higher than the sale price?

If the appraisal value is higher than the sale price, this transaction can keep moving along as planned. The expert opinion of the appraiser is that the value of your soon-to-be new home is higher than what you’ve agreed to pay. Congratulations—you already have equity in your new home!

The value of an appraisal

The appraisal process isn’t meant to put a roadblock between you and your dream home—it’s there to protect you and the lender. You don’t want to unknowingly overpay for a home, especially if you need to sell it in the short term. It could be worth less than you owe, and that’s an unfortunate situation for everyone. From the bank’s perspective, they don’t want to own a house they can’t sell to cover the outstanding loan balance in case of a loan default.

In the home-buying process, the appraisal is just one of many things that need to occur to get to the closing table. Regardless of whether your appraisal comes in high or low, understanding the process is your best defense to managing the hurdles until you get to your home sweet home.

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