After months of making offers, you finally get an offer accepted. Escrow is opened and the lender orders appraisal. The appraisal report comes back and to your astonishment, the house of your dreams comes back under Sales price. In order words, the value is less than the purchase price….What do you don now??

First, what is an appraisal ?….An appraisal is the  monetary value on a property given by a licensed home appraiser.  appraising a property a home buyer has an idea of the “fair market value” on home.  The appraisal helps to determine whether you’re over-paying for a home relative to similar for-sale homes, or getting a “good price”. In a refinance , the appraisal  report — except those using a no-appraisal-needed streamlined refinance — the appraisal helps to determine your mortgage eligibility.

An appraiser has different methods for arriving to a “Fair Market Value”.In residential loans, an appraiser  uses the Sale Comparison Approach method. Via the Sales Comparison appraisal approach, a home appraiser will compare your home to similar homes in the immediate vicinity with similar physical attributes

An appraiser will utilize the value of homes that have sold, within a mile radius from your property and that have sold in the last 3 months. In some rare cases, an appraiser will go over a mile radius to find comparable sales and properties that have sold in the last 6 months. The appraiser looks at the properties with common traits to your. For examples of such traits includes number of bedrooms; number of bathrooms; age of home; quality of home finishes; and square footage. Location matters, too, such that similar homes in different school districts may have different appeal and may not be considered “comparable.

Once an appraiser arrives at a value, he issues the appraisal report. A copy of  appraisal report is given to you and to the lender. The lender will use that value to determine you down payment

What does the lender do if the appraised value is less than purchase price?

In mortgage lending, your loan is determine by the value or sale price which ever is less. In other words, if you purchase a $350,000 house with  an appraised value is $340,000, and you are planning to make a 3.5% down payment via the FHA, your down payment is calculated the following way:

Sales Price $350,000

Appraised Value $340,000

Down Payment=340,000 x 3.5=$11,900

Since your property appraised for $10,000 less than the Sales price, you have three potential outcomes :

1.Buyer and seller renegotiate a new, lower home sale price

2.Buyer increases down payment to meet new LTV and down payment minimums

3.Buyer chooses neither option, and cancels home purchase contract

The possibility of a “bad appraisal” is among the reasons why the majority of home purchase contracts are written with an appraisal contingency. In the event that the home fails to appraise for its purchase price, the contingency clause gives buyers an opportunity to re-evaluate. Unless, you agree to pay the full price. This is becoming a common practice in highly desirable and in demand neighborhoods.

In this highly competitive market where house inventory is low and competition is  very high, many sellers will tell you ,up front, that if the property does not value, you still need to come up with the difference. For example, based on the scenario above,  if down payment is $11,900 and you agreed to come up with the difference, your new down payment will be $11,9000 plus $10,000 difference.

What can I do?

If you plan to buy a home in 2013 or 2014, consider your household budget and your expected home down payment. Talk to an experienced Realtor and ask about his/her experience with under value properties. An experienced Realtor will perform a value analysis on the property that you want to purchase and give you an idea of the current value of the house. Remember, an appraisal can change your math, and so can rising home prices. In this new market, you need to PREPARE, PREPARE and PREPARE!!

Call me see how much home you can afford and start getting prepare for the purchase of your dream home– it’s free and there’s no obligation whatsoever!

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