In the midst of a real estate transaction, the last thing that anyone wants to consider is what happens if the appraisal comes in low. That discussion usually starts with a common expression involving excrement and then “now what happens”? The buyer’s loan amount is based upon the lower number between the contract price and appraised value. Experienced agents usually understand how to limit real estate appraisal issues, but it sometimes happens. The argument “the market dictates value” may be true, but appraisers write reports for underwriters and there are strict protocols that they must follow.
Appraisers are required to follow specific requirements and their reports are checked and reviewed. There is absolutely no reason for an appraiser to “kill a deal”. If there is support for the contract price, the appraisal will reflect that. If not, it won’t.
The “low appraisal” fuse is lit by the mortgage lender. Usually an email follows a call giving notice that the appraisal has been completed and is attached. The buyer is required to confirm receipt of the appraisal. Assuming that the buyer’s agent wrote a proper and complete contract, the financial exhibit directs that an amendment with the appraisal report attached be sent to the listing agent. The amendment states that the purchase price will be reduced to the appraised value. Upon receipt by the seller, one of three things will happen.
The appraisal comes in low, the contract price is reduced
The amendment sent to the listing agent requests a reduction of the contract price to the appraised value. Since the loan is based upon the lower of the contract or appraised value, this is an expected request by the buyer. The seller is not obligated to agree and can say “yes” or “no”. If they agree, the contract is adjusted and the deal moves along. If the seller says “no”, the buyer can terminate the contract with full refund of earnest money.
The appraisal comes in low, the buyer covers the difference
If the seller refuses to lower the sale price to the appraised value and the seller still wants the home, the difference between appraised value and contract price must be made up. The loan is based upon the appraised value so the buyer will bring funds to cover the shortfall. This happens, but infrequently as many buyers are heavily leveraged. If a seller has the desire and the means to do this, the deal moves along.
The appraisal comes in low, the difference is negotiated
This is the most common outcome when an appraisal comes in lower than the contract price. It starts with the request to lower price and evolves with both sides looking for a happy medium. The buyer brings funds to cover the short and the seller reduces price. There are no rules here and much depends on the negotiating skills of the agents and the motivation of the buyer and seller. While splitting the difference seems convenient, the ratio can swing in any direction.
And don’t forget these critical points about home appraisals
- An FHA appraisal “runs with” the subject property for six months, the case number is unique and will note past appraisals. If an FHA loan terminates because of an appraisal issue and the next buyer also uses an FHA loan, past appraisal issues will be noted. This is critical for sellers to remember if FHA buyers are expected.
- Sellers must keep everything in perspective in the event of a discrepancy. The emotional side must be checked; a home sale is a business transaction. The objective of a seller is to obtain the best price and best terms possible. In that light, it is best to consider all of the options in the event of a value issue and not make a rash decision.
- Buyers should not “play the appraisal game”. A tactic in competitive markets is to overbid, lock a property up and wait for the appraisal to come in low. In some markets, strong activity is fueling price increases. Appraisers are concerned with providing a well-supported report that accurately reflects the current market while meeting underwriting standards. Use experienced agents, know the market and present an offer based upon reliable comparable data.
- Should home sellers get a prelisting appraisal? Some agents recommend them, especially if they don’t want to cross swords with sellers when it comes to list price. In some cases, having an appraiser to speak “appraisal-ese” with the lender’s appraiser is a huge benefit. A segment of agents either lack the objectivity or skill to present a compelling supporting argument to appraisers. It’s fascinating how differently agents and appraisers see the same data.
- New homes often have exclusionary clauses regarding appraisals, builders are no longer willing to risk valuation issues when buyers add options. The lender will require an appraisal but should appraised value come in below contract price, the buyer may still be forced to close. That “deluxe kitchen package” they charge $35K for isn’t likely to be reflected by the market. Again, always use a buyer’s agent when building a home. The builder pays for representation, use it.
No appraiser takes an assignment hoping to disrupt a transaction. However, as the independent eyes of the lender, appraisers are required to impartially evaluate the property using the criteria stipulated by the underwriters. Things occasionally get sideways, when that happens it’s best to step back and breathe. Work only with experienced and capable agents, pragmatically evaluate the situation and make the best business decision at the particular time.