Understanding property valuations

Katia Savchuk – Mediafeed

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 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.

Related: Mortgage calculator

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.

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.

What if you get a low appraisal?

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.