Imagine...you're under contract, you've made it through inspection negotiations and are almost at the finish line...then the home doesn't appraise. What happens next?
Let us start with the importance of pricing a home correctly. When we, as Realtors, set a price for a property, it is with significant research. The surrounding properties that have sold in the last six months to a year, and those "pending" aka under contract, are the basis for this research. We search for the homes that are most similar in size, condition, geographic location, style, number of bedrooms & bathrooms, features, and updates to the property in question.
In the last couple years, however, home prices have been rising so quickly that there have been many instances where the appraised value did not meet the sales price. With the exception of being able to use "pending" properties, appraisers consider the same factors as Realtors, but this doesn't mean they always end up with the same value.
The purpose of the appraisal is to protect the buyer, and their lender, who holds the loan, from over-paying. In the mortgage world, there is something called a Loan to Value (LTV) ratio. This is the value of the home minus the buyer's down payment. If the appraisal is less than the sales price, the bank's LTV increases, thus increasing it's risk.
For example, if the buyer is financing a $200,000 home with an FHA loan that requires a minimum down payment of 3.5% ($7,000), then the bank will not lend more than 96.5% ($193,000) of the appraised value or sales price (whichever is lower). So what happens if the appraisal comes in low at $195,000?
If the appraised value doesn’t meet the sales price, the buyer can ask the seller to reduce the price to the appraised value. Sometimes they agree and that’s the end of it, but other times they don’t. If the seller says no, the buyer can either walk away without penalty or escalate to plan B...
Which is - dispute the appraisal. The buyer's Realtor will first notify the lender that they are disputing the appraisal. They will then sift through the appraisal report, seeking any discrepancies or misrepresentations of value for the comparable properties that the appraiser has used. The buyer's Realtor will also seek out other comparable properties, as the appraiser may not have chosen the best matches. The seller's Realtor will provide the comparable properties that they used to price the home as well. This will all be submitted to the lender, in a timely fashion, for the appraiser to review. The appraiser will then decide to either increase the value or stick to their original assessment.
In the event that the appraiser doesn’t increase the value, the parties are back to working it out or walking away. In our example above, the appraisal was off by $5,000. Let's say the seller offers to meet in the middle and reduce the price by $2,500. If the buyer is making up the difference, it is coming out of their pocket and cannot be financed. The lender will not contribute more than 96.5% ($188,175) of the appraised value. This means the buyer will need to bring at least 3.5% down ($6,825) plus and additional $2500 to closing.
It is vital to have your Realtor perform a comparative market analysis before listing or writing an offer on any property to avoid running into an appraisal issue. However there may be situations, such as rapid escalation of prices or bidding wars, which can cause market value to differ from the appraised value. By working with an experienced and attentive agent, you'll have someone on your side to advocate for you and advise you on the best path forward should problems arise.