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Photo credit: Jakub Żerdzicki
An appraisal is an independent assessment of a property’s value, conducted to protect the purchase’s funder from risk. Since most property purchasers borrow the money to make these purchases, this protection is generally for a lender. It is important to lenders to not lose money on their investments. Lenders want assurance that they are not lending more money than a property is worth.
The Appraisal Process
Buyers order and pay for (via their lender) the appraisal after signing the sales agreement. A licensed appraiser then visits the home and records specific details about the home’s characteristics and condition. The appraiser compares this information with similar properties recently sold. If the home “appraises”, the appraiser deems the sales price in line with comparable properties. The sale continues as planned.
Sometimes a home does not appraise — that is, the appraiser determines the value of the home is less than the agreed upon sales price. As the buyer and seller have an executed sales agreement, the buyer is still obligated to purchase the home at the agreed price unless their offer paperwork included an Appraisal Contingency Addendum indicating otherwise.
The Appraisal Contingency Addendum
In general, the Appraisal Contingency Addendum allows the buyer to select from the following options:
- The buyer can choose to terminate the agreement and get their hand money back or re-engage in negotiations with the seller aimed at reducing the sales price (and if the parties cannot come to an agreement, the buyer is able to terminate the agreement of sale and receive their hand money back).
- The buyer can choose to pay the difference between the sales price and the appraised value at closing (added to the buyer’s closing costs), adjust their loan amount (downward), and/or alter their loan-to-value ratio so the ratio does not exceed the lender’s requirements (possibly requiring a different loan product).
Conclusion
In short, the appraisal is important to both the buyer and the seller. As a buyer, you do not want to make an offer so high that the property will not appraise. As a seller, you need to price your home such that even if a bidding war ensues, the sales price is still likely no greater than the appraised value. A sales price exceeding the home’s appraised value can put the transaction at risk for delays or even not closing.
