Contract to Close: Bank Appraisal of the Property

So far much of the explanation of the mortgage process after going under contract has focused on the lending bank's assessment of you as the buyer. The appraisal is essentially the bank's verification that the property is also a worthy investment.

Imagine the bank puts forward say, $400,000 of its funds to help you buy a $450,000 place and it becomes clear afterwards that the home is only worth about $375k because of some overlooked foundation, window, and roof problems. Even though the bank has your mortgage agreement promising that you will pay back the $400k and you would be the one who has essentially lost $75k, the bank knows that circumstances may render you unable to pay (say, a lost job or a having to sink funds into repairs that are immediately required). If that occurred and the bank had to take possession of the home, they would likely sell it for less than the borrowed amount of money in the scenario above and take a loss. The appraisal is an effort to guard against this. Of course, the buyer does not want this situation either and typically orders a more thorough home inspection to protect against making a poor investment.

Sometime between contract and close, the lender will send one of it's appraisers to meet the selling agent and tour the property. From this usually quick effort, the appraiser decides if the purchase price is justified. If the appraiser decides the value is likely much more than the purchase amount, that presents no concerns from the lender. However, if the home appraises for less than the purchase amount it may present problems.

Lenders will not approve a mortgage for a purchase price higher than the appraisal amount, so the amount they lend you as the buyer would be similar to if the home was purchased for the lower appraisal value. Sometimes the seller might be willing to reduce the purchase price since this problem is essentially a shared problem rather than something strictly from the buyer (the seller would likely have this problem with another buyer if the contract was cancelled by either side). However, if a buyer is able to pay the difference between the appraisal price and contract price and still be approved for the loan, that is often a solution, too (though not great for the buyer). Of course, some combination of reduced purchase price and a buyer paying more out of pocket is a solution, too. If the appraised value seems inaccurately low, either side may contest the appraisal with comparable properties to support the higher price.

Lenders can sometimes be overly cautious based on appraisal results, and on top of that appraisal values have a reputation for being somewhat arbitrary at times (it is less thorough even though appraisers are licensed, trained, and the process is highly regulated). For that reason, it's usually not advised for buyers to share home inspection reports with lenders because these reports are by nature thorough and intend to draw attention to problems a property has. This is helpful for negotiating with the seller to have those problems fixed or perhaps receive compensated through financial credits, but a lender's awareness of the problem can threaten to kill a deal. For example, a recent client discovered two foundation cracks on a home he was under contract to purchase during his inspection, and his appraiser discovered them as well on a separate visit. The bank decided they would not approve the mortgage unless these were addressed by a licensed waterproofing specialist, and it proved difficult to find someone on short notice. Although the closing was delayed, we did end up receiving a repair quote for about $1,000 and the bank approved the mortgage.

As a buyer, typically nothing needs to be done with the appraisal except pay for it. Your lender will order the appraisal and the appraiser will schedule it with the seller's agent.


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