If you're in the market for a new home, chances are, you're not planning to buy it outright. Rather, you're probably planning to take out a mortgage and pay off that home over many years.
But there are certain requirements that must be fulfilled before your home loan is complete, and one of them is your home appraisal. And if that appraisal comes in lower than expected, it could kill your chances of getting to close on your mortgage loan.
What is a home appraisal?
A home appraisal is an unbiased assessment of a property that’s performed by an outside professional who’s been trained to determine home values. During the appraisal process, an appraiser will observe a home’s physical condition as well as its features. These include:
Appraisers also look at comparable home values in the area to determine a property’s value. As such, a home in pristine condition that might be valued at $400,000 in one housing market may only appraise for $300,000 elsewhere based on location.
Keep in mind that a home appraisal is not the same thing as a home inspection. The purpose of a home inspection is to check for flaws or issues with a home that’s under contract to be purchased, but that’s also something you, as a buyer, pay for yourself, and it’s your decision whether to use the information from your inspection to renegotiate a purchase price or even back out of a deal. Your mortgage lender, however, doesn’t need to see the results of your home inspection to close on your home loan.
Why is a home appraisal needed?
The purpose of a home appraisal in a real estate transaction is to ensure that a home is worth what you think it is. If your home's value isn't high enough to support the mortgage you're asking for, your lender won't go through with the transaction, and understandably so.
Imagine you're trying to buy a $200,000 home that only ends up appraising for $150,000. And let's say you're putting down 20%, or $40,000. That means you're borrowing $160,000, which is more than your home is worth based on its appraisal value. If you default on your mortgage, selling your home wouldn't even be enough to get your lender repaid. Clearly, lenders don't want to take that chance.
Furthermore, if you’re looking to refinance your mortgage, you’ll need an appraisal of your current home for the same reason -- to ensure you’re not borrowing more than what your property is actually worth.
If your home appraisal comes in lower than anticipated, it could wreck your chances of closing on a new mortgage or getting to refinance. Here's what you can do if that happens.
1. Negotiate a new purchase price
There may be a reason why a home appraisal comes back lower than you expect it to. It could be that certain features are outdated or that home values in the area have been on a decline in recent years.
If you’re trying to buy a home and you agree with its low appraisal -- meaning, you understand why the value of the home you’re looking to buy is coming in lower than initially expected -- then it pays to try negotiating a lower sale price with your seller. Going back to our example: If the $200,000 home you're looking to buy comes in at $150,000, you can try seeing if your seller will drop his or her contract price substantially. Your seller may not agree to $150,000, but perhaps he or she would be willing to meet you in the middle, and if you’re in love with the home, you might agree to just pay the difference yourself rather than borrow it.
Of course, if you’re looking to refinance and you agree with your low appraisal, you may need to change the loan amount you’re asking for so that you’re not borrowing more than what your appraisal calls for.