If you’re thinking of taking out a mortgage, you probably expect lots of paperwork. The lender will likely take a look at your income, debt, credit history, employment, and assets, among other factors. There’s another loan element the lender will consider that may be less familiar: a home valuation.
It makes sense that a mortgage lender would want to know how much the property you intend to buy is worth. A seller can choose any listing price he wants—whatever they think someone is willing to pay, however, if the buyer needs financing then the selling price must be supported by market value (what like for like homes have sold for in the area)
Of course, most sellers keep in mind what comparable properties are going for, but there’s no requirement that the listing price reflects a reasonable value. And sellers usually have an incentive to inflate the price.
An independent property valuation helps the lender mitigate risk by ensuring that the home is actually worth at least the amount of the contract sales price.
The purchase price of a home is usually spelled out by the lender as being the contract sales price or the appraised value whichever is less.
If the home is appraised for less than the sales price, the seller would either lower the sales price to the appraised value.
If the seller does not want to lower the purchase price, the buyer would be asked to make up the difference. The kind of valuation required depends on many factors.
These may include the type of home you’re looking to buy, the type of loan you’re applying for, the amount of equity in your home, your credit score, and more. Here are some of the common ways that lenders may value homes.
Home Appraisals Explained
The most common kind of property valuation is an appraisal.
How Does a Home Appraisal Work?
An appraisal can be an interior/exterior inspection, exterior only or drive by just to confirm the property is still there. But a full interior/exterior appraisal is an independent estimate of the home’s value by a licensed real estate appraiser and is based on a detailed inspection of the property.
The appraiser looks at factors like the location of the property, the condition of the home (both inside and outside), the size and layout of the home (including the number of bedrooms and bathrooms), the year it was built, and any renovations that have been done.
As part of the standard appraisal process, an appraiser will also consider the prices that similar homes have recently sold for in a specific area, as well as the value estimate used by tax assessors, zoning and more.
The appraisal will determine a market value that is either “as is” or “subject to” certain conditions, such as completion of repairs or upgrades.
Lenders rely on the appraiser’s market value to come up with the loan-to-value ratio of a property, which influences the amount they’re willing to lend and the terms of the loan.
When Does an Appraisal Happen, and How Much Does It Cost?
Lenders usually require a full interior/exterior home appraisal when issuing a new mortgage—though there are some exceptions, as you’ll see below.
The Mortgage Bankers Association recommended leveraging technology to eliminate manual appraisals on mortgages below $400,000.
Most lenders still order a full appraisal even though 68% of all homes fall under the $312,500 threshold. Jumbo loans—those that exceed the conforming loan limits set by Fannie Mae and Freddie Mac—generally require a full appraisal.
The appraisal typically occurs once the seller has accepted an offer on the property, subject to whatever contingencies are in the contract. Because home valuation is part of the loan approval process, the appraisal is normally performed within the loan contingency date of the purchase contract, usually 21 days.
This loan contingency is the contract clause that states the buyers offer is contingent upon securing financing
The buyer is the one usually responsible for paying for the appraisal ordered through the lender and is entitled to free copies of the final document.
The average cost of an appraisal is dependent upon many things such as type of property, location, etc and runs an average of $334, with fees ranging from $250 to $450, according to a national survey from HomeAdvisor, an online platform for home services professionals.
What If You Get a Low Appraisal?
If the appraisal finds that the property is worth as much as the selling price or more, that encourages the lender to move forward with the loan (assuming the other aspects of the property and your application are in order).
If the appraisal finds that the home is worth less, the lender may reduce the amount of the loan they’re willing to offer.
As the buyer, you can either opt to contribute the difference in cash or try to get the seller to reduce the price. Sellers may be willing to negotiate since other potential buyers are also likely to run into a low appraisal.
If you or the seller believe the appraiser made a mistake, the seller can dispute the appraisal with the lender or ask for a second one. The buyer can also choose to pull out of the purchase if the contract included a loan contingency.
Alternatives to a Home Appraisal
In certain situations or stages of the home buying process, you may not need to go through a full formal home appraisal. Here are some alternative methods used by lenders for home valuations.
Automated Valuation Model
An automated valuation model (AVM) is a value estimate for a property using mathematical models. The algorithms take into account the size of the home, the number of bedrooms and bathrooms, recent sales of like for like properties sold in the area, and other factors.
Some lenders of conventional mortgages using Fannie Mae or Freddie Mac’s automated underwriting systems may receive a waiver for a full appraisal.
This may be due to the strong data on robust sales in the neighborhood to support the purchase price, could be the amount of the downpayment and strength of the borrower, the type of transaction and more. Some lenders may also use AVMs when deciding whether to extend or adjust a home equity line of credit (HELOC).
Drive-by or Exterior Only Appraisal
As the name suggests, a drive-by appraisal (also known as a summary appraisal) refers to an inspection that only looks at the exterior of a home. A licensed appraiser will photograph the front and sides of the home, as well as the street in both directions.
Appraisers take notes on the neighborhood and the condition of the home. They also look at comparable properties that have recently sold or listed nearby when coming up with an estimated value.
Broker Price Opinion
A broker price opinion, or BPO, is an estimate of a property’s value determined by a real estate agent or broker, rather than a licensed appraiser. A client may request this estimate to underpin a home’s listing price.
A BPO may be requested by a lender on a property where the borrower is behind on payments and risks entering into a short sale or foreclosure.
A BPO allows the lender to confirm whether the value of the home is below the amount of the loan, potentially making the borrower eligible to negotiate a short sale.
BPOs can also be used to buy and sell mortgages on the secondary market.
Lenders prefer to go with BPOs in these cases because a full appraisal isn’t required, and BPO valuations are fast and generally less costly.
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