Since home appraisals are estimates of a home’s worth based upon current market conditions, just how accurate is an appraisal? Appraisals are written reports that are prepared by certified and trained individuals who must complete certain education and job training. Appraisers must adhere to the Home Valuation Code of Conduct or HVCC (the “Code”) for Fannie Mae and Freddie Mac loans when they appraise the property. VA and FHA loans are excluded from the Code.
Lenders require an appraisal be prepared by a certified appraiser when they are lending you money to buy a home or refinancing your current home to ensure that they will be able to recover their investment if you default, and they have to sell your home to pay off your loan balance. Buyers rely on appraisals to determine if they are paying the right price for a home, and sellers rely on them to determine the market value of their home when they need to refinance to a lower interest rate, or they want to know what a buyer may be willing to pay for the home when they go to sell it. With so many people relying on real estate appraisals, there is a lot of pressure on appraisers to make sure that the value of the home is in line with current market conditions.
Measuring appraisal accuracy using the sales comparison vs. the comparison approach
Appraisers use several different methods of appraising property. The most commons methods used for appraising residential properties are the sales comparison approach and the cost approach. These methods are recognized by lenders and other industry professionals as the most accurate ways of determining a home’s value.
The sales comparison approach is when the appraiser compares three to give similar properties that have recently sold while making adjustments up or down for improvements, lots size, square footage, upgrades, year built, location of the property and amenities of the property that you are interested in purchasing. The cost approach is used by appraisers when you are purchasing brand new construction from the builder to determine the replacement value to rebuild the home if it were totally destroyed by a natural disaster.
These appraisal methods give you and your lender an accurate way of determining the home’s worth. The lender is looking at both the borrower’s credit worthiness and the value of the home. They want to make sure they can recoup their investment should the borrower default later. While there is no absolute guarantee that the home will be worth the same or more if the lender foreclosures on the property at a later date, it gives them enough information to determine if they want to lend you the money to purchase the home or refinance it at the present time.
Mortgage brokers and real estate brokers must also understand the different appraisal reports so that they can advise their clients whether or not the home is priced right and a good investment.
When market conditions are changing and prices are in flux- either going up or going down, sometimes a home does not appraise. It is important to use a local appraiser that understands the market conditions in the area. When an appraiser is not familiar with the area, they also rely on local Realtors to help them by supplying them with information regarding recent sales and pending sales when there are not enough closed sales to substantiate the value of the subject property.
What Happens When a Home Does Not Appraise?
If a home does not appraise, the buyer has the choice of paying for another appraisal, asking the seller for a price reduction, putting down a higher down payment or walking away from the deal. That is why it is extremely important that the appraisal reflect the true market value of today’s market conditions. If the appraisal reflects the wrong value for a home, a buyer may not be able to buy the home or a seller may not be able to refinance to a better interest rate to lower their monthly mortgage payments. Understanding how appraisals work and how home values are determined is an important aspect of the home buying process. Your mortgage broker, lender or Realtor should be able to explain the appraisal process to you and answer your questions.