What is a home appraisal? Everything you need to know

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Aug 30

Libby Wells | Bankrate.com (TNS)

An appraisal is a critical part of the homebuying process. If your home appraisal comes in lower than expected, it can cost you money and delay — or even derail — the entire transaction.

Here we delve into what an appraisal is, why it's necessary and how it can impact your home loan.

What is a home appraisal?

A home appraisal is an objective, professional assessment to determine how much a home or property is worth.

When buying or selling a home, an appraisal verifies that the sale price of the home is in line with fair market value. This ensures the homebuyer doesn't pay more than the home is worth, and the mortgage lender doesn't lend more than it is worth. Since the home serves as the borrower's collateral, the accuracy of the appraisal matters significantly.

Likewise, when a homeowner is refinancing their mortgage, the lender will have the home appraised to confirm its market value before extending a new loan.

How do home appraisals work?

Once an order from a lender has been received, a licensed appraiser will either make an appointment to visit the home in-person or perform the appraisal remotely.

In addition to this physical assessment of the property, the appraiser also analyzes recent sales of comparable properties in the area, or "comps." This information might be gathered from a variety of sources, such as the local multiple listing service (MLS), tax records, local real estate agents and county court records.

The appraiser also considers the neighborhood surrounding the property. A newer home in a growing subdivision might appraise higher than an old home in a community that's in decline, for instance.

Here's a step-by-step overview of what you can expect when obtaining a home appraisal:

— Your lender orders the appraisal. If you're buying a home, your lender will order an appraisal after your offer has been accepted and you've signed the purchase agreement. If you're refinancing, the lender typically orders the appraisal after you apply for the new loan.

— The appraiser assesses the home. The appraiser will conduct either an on-site visit or a remote evaluation to determine the value of the home. An in-person visit for a modest home might take just 15 to 30 minutes; a larger home can take a few hours.

— The appraiser reviews comps. Along with assessing the property, the appraiser will conduct a market analysis and review public records to determine what similar properties are worth, and how those relate to your home's value.

— The appraiser delivers a report and valuation. Once the information has been gathered, the appraiser will put together a report, typically the Uniform Residential Appraisal Report, for the lender. As the borrower, you are entitled to a free copy of this report before the loan closes. Read it thoroughly and notify your lender if you believe it is inaccurate or contains any errors.

What does a home appraiser look for?

Home appraisers consider many factors when determining a home's value. These might include:

— Location of the home

— Neighborhood (Is it urban, suburban, rural? Is it old or is it newer and growing?)

— Square footage (of both the house and the lot)

— Layout of the house

— Hazards, such as flood dangers or other adverse conditions

— Age and condition of the foundation, roof, walls and overall structure

— Amenities, such as a fireplace, deck or swimming pool

— Condition of appliances

— Sales trends and price ranges for comparable homes in the neighborhood

The appraiser might also look at whether there is any rental income or fees associated with the property, such as homeowners association fees, as well as the cost to build a similar home from the ground up.

How an appraisal determines a home's value

As the above list shows, appraisals are based on a lot of factors, some of which might not have anything to do with the house itself. For example, if a neighborhood has a lot of distressed home sales, that tends to lower the value of other nearby homes (no matter how nice they are). Generally, the location, age, size, amenities and condition of a home, along with comps, are the key factors the appraiser uses to determine value.

What if the appraisal comes in too low?

A lower-than-expected home appraisal can spell trouble for a home sale. If this happens, the first thing to do is look over the appraisal report closely to check for errors that could account for the unexpected valuation.

If your sale contract has an appraisal contingency, and the appraised value is lower than the amount you've agreed to pay, you can likely decide to back out of the deal and get your earnest money deposit refunded.

Alternatively, you might decide to negotiate with the seller for a price closer to the appraised value. If you still want the house and the seller is unwilling to negotiate, a lower appraised value could force you to put more money toward the down payment to make up the difference.

If you're getting the appraisal as part of a loan refinance, you might still be able to refinance by offering to make up the difference. You may also consider asking for a second opinion, especially if you think the first appraiser made some factual mistakes, such as basing their valuation on a belief that the home has fewer rooms or less square footage than it does in reality.

How to prepare for a home appraisal

For homebuyers

— Know your contingencies. Home purchase agreements often include an appraisal contingency that allows you to walk away from the deal if the appraisal turns out lower than expected. Make sure you understand the contingencies that are in place before you sign a contract on a home.

— Don't feel pressured to make a higher offer. A competitive market can make it tempting to offer more than a house is worth. Don't go overboard if you don't have the extra cash to cover the difference between a higher offer and the actual appraised value.

— Accept that the outcome is out of your control. As the buyer, you don't have much, or any, influence over the results of the appraisal. Make sure you have the right contingencies in place in advance so that if the valuation isn't in line with your expectations, you can walk away safely.

For refinancers

— Prepare your own comps. To help avoid a low appraisal, give the appraiser a list of properties in the area that you believe are similar to yours. Your real estate agent might be able to help, or you can research online listings.

— Make a list of improvements. Get maximum credit for renovations or repairs you've done by providing details about work completed on the property. Provide photos and receipts if possible.

— Clean and declutter. If the appraiser is coming to your home, put in some effort to make it look its best by tidying up and stashing clutter out of sight. Mowing the lawn, raking leaves and cleaning up flower beds couldn't hurt either.

Other home valuation models

Appraisals are the most accurate home valuation method for determining the fair market value of a property, but they are not the only option available.

Your real estate agent can put together a comparative market analysis that examines the local market and how your house measures up. These are definitely valuable tools, especially early on in the process.

You can also check various automated valuation models, such as Zillow's "Zestimate," which provide an algorithmic assessment of the value of your home using publicly available data. These are more time-efficient than an appraisal, as they can be performed online almost instantaneously. However, results can vary widely and they do not take into consideration the condition of the property in the same way a human appraiser does — nor can they necessarily provide the same insight into a local market.

Home appraisal vs. home inspection

One last note: Appraisals and inspections both involve an outside professional assessing the home, but they're very different things.

— Home appraisal: As discussed above, an appraisal assesses the value of the home as a dollar amount. It's required by mortgage lenders, primarily as a security measure — so they can ensure they're not loaning you more than the house is worth.

— Home inspection: An inspection, however, assesses the condition of the home. This is done for your benefit as the buyer, and while it's not required, it's standard for good reason. You don't want to move in only to find out the first time it rains that the roof leaks, or to discover when winter rolls around that the heating system needs replacing. A home inspector will look at the property's structure and major systems to evaluate for safety and functionality — so you know about problems with the house before they become your problem. Buyers often use the inspection report as a negotiating tool, asking sellers to cover the cost of needed repairs.