It’s funny, because 5 years ago “home appraisal”, or sometimes known as “bank appraisal” wasn’t a topic that came up very often. Home prices in Guelph are rising significantly due to a huge increase in GTA buyers. Now, we hear more and more about home appraisals. This post will discuss them a little deeper.
What is a home appraisal?
A home appraisal is the banks reassurance that what a buyer paid for the home is actual market value of the property. Your lender, who provides you with a mortgage wants to ensure that their own risk is limited when they’re approving you for a mortgage.
It’s worth noting that in the event you don’t require a mortgage (you’re purchasing in all cash), a home appraisal isn’t relevant.
Home appraisals are done on all types of homes, from detached, to semi-detached, condos and more. It’s much easier to determine appraisal value of a condo, because they’re very similar in design, layout and size. Detached homes typically require a little more expertise
However, for the rest of us that do require a mortgage, let’s use a home appraisal example:
You find a home you love and the asking price is $799,900. However, the seller has elected to hold offers and will be reviewing any and all offers next week. Using a holding offers strategy is an indication that the seller/ agent believe that the house will sell over the asking with multiple offers.
You and your Realtor do your homework and sure enough- recent comparables show that the house is likely worth around $900,0900 in todays market.
Offer day comes around and there are 5 offers on the house. You really want it (because it’s awesome) and decide that you don’t want to lose it. So you offer $1 million dollars without any conditions (most likely that’s without a financing or home inspection condition).
Now what happens in the home appraisal process?
Your bank (let’s say it’s RBC), the one who is giving you a mortgage isn’t in the business of home appraisals. So, their process is to hire a 3rd party company. They specializes in these to go out and appraise the house. The 3rd party goes to the house, assesses the lot and interior and then pulls recent comparable sales. They determine what fair market value is and give that report to the lender (in this example, RBC).
And let’s also assume that the home appraisal comes back at what we already knew market value was: $900,000.
RBC comes to you, the buyer and says they have a problem: You paid $1 million for the home but the appraisal says it’s worth $900K. That’s a $100,000 gap.
Uh oh, now what happens?
RBC is going to tell you that you need to make up the difference in the appraised value. This is $900K versus the $1,000,000 you paid in order to get a mortgage. In other words, you need to find an extra $100,000 by the closing date.
This should be factored in and ideally you have a larger downpayment that can cover this. If not, you’re putting yourself at significant risk.
What are the buyers options?
Buyers have a few options here. As banks have been bombarded with mortgage requests over the past year, appraisers have also been hard at work trying to keep up. Often times, the banks end up with an appraiser who isn’t familiar with the local market. This means that the appraisal may not be using the best comparables.
- You can ask the lender to get a second opinion (another appraisal). After all, it’s tough to just make a decision on one persons opinion. The banks may agree to do this, they may also pass the cost onto you, the buyer.
- You can appeal the current appraisers value. This would require input from a Realtor who has access to the same comparables
- You can simply pay the value difference that the lender tells you that is required (in this case, $100,000).
One thing a buyer cannot do, is attempt to get out of the transaction. They are in a firm and binding agreement that could have serious, significant financial implications. Sometimes buyers think they can just forfeit their deposit- but it’s not the case at all.
Is just paying the difference a bad idea?
Not at all. If you have access to another $100,000, it just means that you need to borrow less and your mortgage will be $100,000 less. It just puts less risk on the bank if your downpayment goes from 20% to 30% because you have to pay more upfront.
How do you avoid issues with a home appraisal?
The easiest way to avoid an appraisal issue is to have a financing condition in your offer. However, this is not likely to fare well in a strong sellers market. Additionally, financing conditions are usually 5 business days. However it can sometimes takes weeks to get a home appraisal (meaning the financing condition isn’t likely to help anyways)
Beth and Ryan suggest familiarizing yourself with prices for similar homes in the area. Doing this over time (or reviewing comparables) can give you an familiarity of similar priced homes.
The other point is that in a sellers market, new high prices are being set all the time. As a result, an appraiser has to take market conditions into consideration when appraising homes.
If you are considering a home purchase and want more information on home appraisals, email Beth and Ryan and they’ll be happy to help!
This blog is part of a series 23 Most Common Real Estate Terms (2022)