If you have ever bought or sold property, you have probably heard the term “appraisal.” An appraisal is just one of the many factors that affect a real estate transaction, but it is also one of the most important. In fact, the result of an appraisal can completely change a transaction or even cause it to fall apart. So, what is it, and how does it work?
An appraisal is generally defined as “an estimate of value”, which, in this case, refers to the value of real property. These estimates are very carefully calculated based on specific rules and methods. Only licensed appraisers are legally allowed to appraise property, and appraisers in Georgia must take a 90-hour curriculum and pass a comprehensive exam in order to become licensed.
Since these estimates are heavily regulated, they are typically used by mortgage lenders to determine the loan amount they will provide. In this post, we will be talking about the appraisal process, how it affects real estate transactions, and how to prepare for it when buying or selling property.
What is an appraisal?
When a buyer applies for a mortgage in order to purchase real property, their lender will typically require an appraisal on the property. This is a professional opinion of value performed by an unbiased third party, who must be a licensed appraiser. The lender will use this value to determine if the price of the house is appropriate, and to make sure they are not loaning the borrower more money than the house is worth.
On the other hand, if a buyer intends to pay for a house with all cash, they may not need an appraisal. Mortgage lenders are not involved in cash transactions, so buyers can simply offer the amount of money they feel comfortable paying. However, some cash buyers may still want to know the appraised value, and so they can order an appraisal on their own.
How is an appraisal calculated?
The basic method of performing an appraisal involves “an in-person inspection, research into recent sales of similar properties, current market trends, and the details of the home, including its size, condition, floor plan, and amenities” according to Investopedia. An appraiser will first look at the property itself, making notes about specific features and amenities. This might include the number of bedrooms and bathrooms, square footage, materials used in construction, appliances, and more. They will also look at neighborhood characteristics such as location, marketability, growth, and environmental conditions.
Next, appraisers will review details about several comparable properties in the neighborhood that are either for sale or have been sold recently, aka “comps.” They will typically narrow down these comps and select three that are most similar to the subject property, or the one being appraised. The appraiser will then make a list of the features and amenities that apply to each comp.
During the comparison process, the appraiser will make adjustments to the sale price of each comp based on how it compares to the subject property. For example, if Property A has a 2-car garage, but the subject property only has a 1-car garage, the appraiser might deduct a few thousand dollars from the sale price of Property A to reflect the value of having a bigger garage. After all adjustments are made, the appraiser will calculate the appraised value from the adjusted prices of each comp, giving more weight to the most similar properties.
How does an appraisal affect real estate transactions?
The majority of home buyers apply for a mortgage to finance their purchase, and in most cases, their lender will require an appraisal to be performed on the property. If the appraisal comes in lower than the purchase price they agreed to pay, the amount of money available for the loan immediately drops.
For example, if you apply for a loan to purchase a $250,000 home with a 5% down payment, you are promising to pay $12,500 in cash, and the lender is promising to pay 95%, or $237,500. If the appraisal comes in low at $240,000, the lender will only provide $228,000. However, the seller is still expecting the full $250,000, and you are now forced to come up with the rest of the cash.
Since this situation would be impossible for many home buyers, there is an option within a real estate transaction to make your entire deal contingent upon the appraisal. In other words, if the buyer uses this contingency, they are legally allowed to walk away from the deal if the property is appraised for less than the purchase price. Although, in some cases, the seller is willing to lower the purchase price rather than lose the deal.
How to prepare for an appraisal
Since we know that the result of an appraisal can affect both buyers and sellers in a real estate transaction, it is important to prepare for this process before a difficult situation arises. For buyers, it is wise to either set aside some extra cash to cover an appraisal gap or to utilize the appraisal contingency in your offers. Remember, even though appraisals are very methodical, they are still performed by humans, and the results may not be what you expect.
For sellers, it may be helpful to get an appraisal performed on your home before listing it for sale. As an alternative, ask your real estate agent to pull some comps and help you estimate the appropriate value of your home. This way, you can price your home correctly in the first place. Or, if you decide to accept an offer with an appraisal contingency, you will have an idea of whether or not you are at risk of losing the deal.
Key Takeaway
In conclusion, there are many complex factors involved in the appraisal process, but each of these factors is carefully evaluated in order to come up with an accurate value estimate. This estimate is extremely important in a real estate transaction, which is why it is important for both buyers and sellers to fully understand and prepare for it.
Our experienced agents here at Sheridan Solomon and Associates will help you understand each step of a real estate transaction, including the appraisal and how it might affect you. If you want one of our agents by your side as you prepare to buy or sell property, just give us a call or reach out on our website, www.sheridansolomon.com.
