The Appraisal Process in a Real Estate Transaction
Appraisals are often a very important part of a real estate transaction, particularly when it comes to lending. Nearly all lenders will want to see that the subject property appraises at or above the purchase price in a transaction. The main reason for this is that in the event of a foreclosure or repossession, the bank has a reasonable chance of recuperating what it had originally loaned.
When is an appraisal ordered in a real estate transaction?
The timing of an appraisal can vary based on when the closing is scheduled and how a property is being paid for. For example, in a cash transaction, a Buyer could order an appraisal as soon as they choose to. More transactions today are done with a Buyer obtaining funding for their home purchase. After the Buyer submits an application with their lender (typically within 5-7 days of acceptance of an offer,) the lender will then order an appraisal through a third party management company within 10-14 days. This means that the appraisal process is completed in 3-5 weeks of the execution of a contract.
Comparative market analysis (CMA) vs. Appraisals
When a realtor prepares to list a residential property for sale or helps a Seller come up with an asking price, similar approaches are used to obtain a home’s market value.
Often, we refer to this as a comparative market analysis, or CMA. Using properties of “like kind,” realtors compare active, under contract (pending) and properties that have already been settled (within 6 months on average) to the Seller’s property. This includes factors like location, acreage, bathroom/bedroom counts and other factors. Agents compare those to see what the market is like for the home based on current/recent competition.
Although this is more informal, it is an important step as an appraisal will essentially take the same information into account. If the CMA is not accurate or current, then the appraisal will not match and the asking price will be flawed.
Risk of overpricing
If a property is overpriced, it usually has a harder time selling. Overpriced usually means longer days on the market searching for the right Buyer and properties that are for sale can develop a reputation quickly. If a property is on the market too long, people suspect there might be significant repair issues with the home or Sellers that are hard to work with. Additionally, Buyers tend to look at fresh listings first, so a home on the market for a longer period of time simply won’t be looked at often as other homes relegate it to the back of search results.
Sometimes a Seller (and an agent) can get lucky and regardless of a property being overpriced, a Buyer might be willing to pay the higher value if it fits their needs or if there is a shortage of properties. However, it is important to keep in mind that even though a Buyer may be willing to pay more than what a home is currently worth the lender might not agree. If an appraisal comes in below the purchase price it could affect the Loan to Value Ratio(LTV).
As an example, if a Buyers offers $400,000 to buy a property with a down payment of 20%, the Buyer’s LTV is 80%, or $320,000 (the amount of the loan the Buyer is asking from their bank.) If the property appraises for $380,000, that would mean that the lender would typically only be willing to lend 80% of $380,000, or $304,000, which obviously does not cover the cost of the property. The solution in that situation is one of several scenarios
- The Seller reduces price to $380,000.00
- The Buyer makes up the difference and pays an additional $16,000.00 in cash
- The Seller and Buyer negotiate the difference
- The Buyer could terminate contract
More often than not, a buyer is unwilling to pay more than appraised value outside of extreme circumstances (eg., competitive market with bidding wars and/or very low supply.)
Appraisals gone bad
Not all the blame lands on the real estate agent or the Seller who over-prices. Occasionally, there are simply bad appraisals. A common cause for a bad appraisal is an out-of-town appraiser who does not know the market well and can give an incorrect value based on bad comparables. It’s usually not a bad thing for the seller, and not noticed by the Buyer if the appraised value is over purchase price.
However, it is usually not a good thing, especially for the Seller, when the appraised value is under purchase price. There are circumstances when an agent and a Seller can argue or challenge a bad appraisal.
Do it right from the start
In short, it is not worth over-pricing your home. Make sure you hire an experienced realtor who understands the local market and does their due diligence when pricing a property for sale.
Class-Harlan Real Estate and their team of agents are intimately familiar with the Bucks County and Montgomery County areas and have decades of experience pricing homes for their clients and making the appraisal process as seamless as possible.
Interested in selling your home? Speak with one of our agents today to get started!