Listen to this post!
There’s no bigger emotional turning point in the home buying process than the moment a buyer makes an offer on a Waterloo Region home. The transition from shopping for a home to formally choosing one introduces higher levels of anticipation for everyone involved in the transaction. Things get very real.
At this stage of the mortgage loan process, the appraisal is ordered.
Low Appraisals and Loan to Value (LTV)
Appraisals help lenders make better decisions. In fact, lenders only underwrite loans for the purchase price or appraised value, whichever is lower. This is part of the system of checks and balances in the mortgage lending world.
One important underwriting guideline is the loan-to-value (LTV) percentage. The maximum LTV will vary depending on the loan program but there will always be one.
When appraisals come in low, the LTV ratio changes for the worse. In order for the deal to go through, the difference needs to be reconciled but borrowers may not have the cash to cover the gap.
The Role of Comps
A big component of the appraisal process is the use of comparable sales, or comps.
Appraisals are meant to be supported by research, proper methodology and thoughtful analysis. Comps should similar to the subject property in style, location, square footage and sold within the past few years.
Let’s look now and some of the reasons appraisals come in low and things that can be done to overcome such a hurdle to homeownership or to prevent it from happening in the first place.
When markets move faster than normal, appraisal values lag market prices. As mentioned, the appraisal process compares recent past sales. Backward looking data — no matter how recent it is — won’t keep pace with present prices in hot markets.
You might be in a hot market if you see:
- A short number of days from the time homes list on the MLS and when they sell
Very active buyer bidding (people see a home and bid on it the same day)
Multiple bids on a property
People in your social and work circles talk constantly about real estate
Of course, the flip side of a hot market is a sluggish one. Cold markets are characterized by:
- Fewer buyers
Inventory build up
If fewer homes in your area of comparable size and quality have been sold in last 6 months, the lack of comps is going to make it trickier to get the market value of the subject property right.
Lack of Experience
Some appraisers are new to the profession or have not performed an appraisal on a specific type of property. This can mean that their findings are inaccurate, especially if they are not familiar with the area and/or the market.
As we often say here, getting the asking price right is a crucial part of selling a home. Sometimes sellers simply have unrealistic expectations and set their price too high. A good real estate agent will try to step in if this happens, but as any agent knows, sometimes people just won’t budge. However, if the asking price was set too high for the market even if you get a buyer willing to pay it lenders – and thus appraisers – probably won’t agree to and the appraisal will come in low.
A comparable property may have been in terrible shape when it was sold but has since been rehabilitated by new owners. When an appraiser does not understand the property history, the rehabbed home would be a bad comp.
A classic missed comp is a similar property which recently sold but was not yet recorded at the time your appraisal took place. This can happen when government and city authorities are backlogged and tax information (and thus MLS info) aren’t yet a matter of public record.
Homeowners may need to sell a property quickly due to conditions not directly related to the overall real estate market. Death and divorce come to mind as two of the big ones. Sellers motivated only by the desire to get rid of a property will often lower the price to entice buyers. It’s unfortunate when a distressed property is used as a comp because the price is distorted, but not from broader market conditions.
Having the only house in the neighborhood with high-end fixtures, appliances or landscaping may not work out as well as one would hope. If homeowners go bananas to make their house absolutely fabulous — way over and above the style of nearby homes — they will probably not get the return on their investment that they expect. There’s an old saying, “Never own the most expensive house in your neighborhood.”
By the way, improvements made to the main level of a home get more weighted value than improved basements. So blowing $5,000 on a rad “man cave” in the basement for hockey season will not an efficient use of capital if you’re expecting a monetary return.
There is no polite way to say this. A dirty, messy home on the inside or outside will not get a free pass. A tired property will take a hit. There’s a price for ugliness and it’s a negative number.
Ways to Handle Low Appraisals
Before the Appraisal
Agents and/or sellers can meet with the appraiser during the appraisal and provide a list of comparable properties. Be ready to politely point out features of the home and the neighborhood.
Don’t Annoy the Appraiser
Making a case to an appraiser should not come across as coercion. Your only goal is to make sure you miss nothing. In fact, one of the best tactics is to convey information as a question, such as, “Did you notice that all the appliances were Energy Star compliant?”
Did you make any upgrades or do some rehab work to your home? It’ll help to show before and after pictures of any improvements to the property. It wouldn’t even hurt to show receipts.
Having a clean home on the inside and out is huge. Eliminating clutter and dirt is basic and necessary. Not only will it contribute to the fight against a low appraisal but it’s also essential to marketing and showing the property to prospective buyers.
Keep Emotions In Check
If you put in some upfront effort, like creating a package of information about your property for the appraiser, you should be able to relax a bit. Being prepared is the best medicine. And if an appraisal comes in low, there are still measures one can take.
After a Low Appraisal
Hopefully, you prepared for the appraisal. But despite those efforts, what happens when appraisals come in low? Well, this is obviously a tougher situation. But not a hopeless one.
Agents need to be available for phone calls to answer any of the appraiser’s follow-up questions. Of course, this requires that the agent knows the details of the subject property and something about the comps.
In an ideal negotiation, both parties will find a way to get the deal done. Here are some scenarios:
The seller goes down to appraised value.
The buyer goes up to asking price.
Both parties split the difference – buyer puts in more, seller comes down. The parties reach a split such as 50/50 or 70/30. Sometimes sellers can cover the closing costs as a way to make up ground.
Look for Errors
Double check all the data in the report. Look for any errors in the square footage, the number of bedrooms and bathrooms, etc.
Maybe you don’t feel the comps were representative or adequate, especially if there are short sales or foreclosures nearby and they made no market adjustment. You may challenge the appraisal.
Appraisals can come in low for a variety of reasons. Lots of factors are at play including market conditions, the appraiser doing the work, the subject property being appraised and the comps. Sometimes the appraisal is not even low; sellers merely set misplaced expectations too high, and the pricing was wrong.
There are measures sellers and real estate agents can take prior to the appraisal to help reduce the odds of a low appraisal. And there are countermeasures that can be taken after a low appraisal.And now you know what some of those are.