Whether you are buying or selling a home, the appraisal may be one of those things that can make or break a deal. We've see homes fall out of escrow when the appraisal came in too low.
The bank wants to make sure they get their money back should you default, which means they will not lend more than the house is worth. Your lender will send out an appraiser to tour the home, look at major mechanical systems and note the condition of the home. They will then check comparable home sales in the area and create their opinion of what the home is worth. You may see a couple of appraisals on a particular home.
How does the appraisal affect the purchase or sale of my home?
If the appraisal comes back lower than the selling price, the buyer will have to put more down to make up the difference. If the buyer doesn't have that extra money, the deal falls through.
How does the selling agent ensure a deal goes through? They will advise the seller to accept an offer that has enough wiggle room in the selling price in case the appraisal comes in low. They may also advise that the seller not accept an offer with an appraisal contingency. With no appraisal contingency, you can't back out of the deal if the appraise comes in low or you will lose your earnest money deposit. The selling agent's end goal is to ensure their client's sale goes through, because a house falling out of escrow is bad for both the buyer and the seller.
How can make sure you avoid your home sale falling through?
Save up as much as you can, plus put in bids on homes where you have some wiggle room and/or the houses will definitely appraise higher (e.g. the ubiquitous "worst house in the best neighborhood").
How much will the lender let me pay for this house?
LTV will determine how much the lender will allow you to lend on a particular home. What is LTV? LTV relates to the appraisal and means loan-to-value ratio. LTV is how much the property is worth compared to how much equity you have in the home. The lender wants to make sure that you have enough stake in the house so that you don't abandon the house. If you do abandon the home or stop paying on the loan, the lender wants to make sure they sell the house for enough money to get their investment back.
Be aware that higher LTV ratios mean more risk for the lender, which means you may be paying more for that mortgage (higher interest rates).
|Loan to Value Ratio (LTV)||=||-------------------------------------------|
|Appraised value of house|
Let's say you're looking to buy a house for $500,000 with 5% down ($25,000). If the house appraises for $480,000, the loan to value ratio will be 98% and too high a ratio for your lender.
In the example above, the buyer would likely need to come up with additional down payment funds. If their lender allows a 97% LTV (which would be $465,000 on this house), the additional funds would be $9,400. This can be a bad surprise at closing, if you don't have any additional funds to add and you may fall out of escrow. If you have released the appraisal contingency, you may also lose your earnest money deposit.
Ask your mortgage lender what their maximum LTV is.
This will avoid your disappointment when you find that perfect house that you may not be able to get a loan on.
These are some typical LTVs you may see, but your lender's allowable LTV may be lower:
Conventional Loan : Up to 97% LTV allowed
VA Loan : Up to 100% LTV allowed
FHA Loan : Up to 96.5% LTV allowed
Your mortgage lender is the best source of information for specifics on your loan, definitely make sure you speak to a lender early on, before you start looking. It will clarify what monthly payments you feel comfortable with, how much of a down payment (and closing costs) you should save up and how much of a loan your lender can extend to you. Happy shopping!