What Is an Appraisal?
An appraisal is a process by which a licensed appraiser assesses the market value of a home. The appraised market value is based on factors such as the structure’s condition, its square footage, lot size, any additions or upgrades to it, and comparable properties recently sold in the same market.
In the case of a financed purchase, it’s required by lenders to protect their interest in the home—to make sure the amount they’re loaning out isn’t greater than the market value of the property. Otherwise, it’s optional for cash buyers and sellers—but it could be a good idea for both to make sure they aren’t overpaying or underselling.
What Are the Causes of Low Home Appraisals?
The appraisal value depends on many factors outside of the property itself. And so, there can be several different causes for low home appraisals.
- Timing: many markets are influenced by seasonal fluctuations in purchase trends. For instance, the most competitive time to purchase a home is spring to early summer—so listing prices are higher then. An experienced appraiser should take seasonality into account if it’s a significant factor in your market.
- Market Conditions: a competitive purchase market (“Seller’s Market”) may cause bidding wars that increase the overall prices of homes—which aren’t to do so much with the actual values of the homes and more with demand. In contrast, during a slow market (“Buyer’s Market”), sellers may overprice the property because they don’t realize how much its market value decreased.
- Poorly Conducted Appraisal: an inexperienced appraiser or one who is unfamiliar with the area may overlook essential aspects of the home that may raise its value.
- Few “Comps”: comps are properties with similar characteristics that were recently sold in the same market. If there are few comps—and your appraiser is conservative in their estimates—that may lower the appraisal value.
What Does a Low Appraisal Mean for Buyers and Sellers?
For financed buyers: a low appraisal could be a large kink in the loan approval process. Lenders require the appraisal to ensure the loan amount is equal to or less than the home’s market value. So, in a situation where the market value is lower than what you’ve offered to pay (and your loan amount,) the lender won’t approve the loan for the amount requested.
For cash buyers: a low appraisal means the amount you’ve offered to pay is greater than the market value of the property. That’s definitely a good thing to know before you hand over the money—and it could open the door to asking the seller for a discount on the home.
For sellers: a low appraisal means your buyer may not obtain the total amount of financing they need to purchase the home. Alternatively, they just may not be willing to pay the previously agreed upon purchase price.
How Can Buyers Work Around a Low Appraisal?
Buyers have several options in the case the home appraisal is low:
- Appeal the appraisal: as the buyer, you can challenge the appraisal if you believe it was based on inaccurate information or bad comps or was poorly done.
- Ask the seller for a discount: as a buyer, you can show the seller your appraisal as evidence that they are asking for more than the home is worth. The seller should realize that if you were to walk away and they were to sign with another buyer, the second buyer’s appraisal may render the same result. And, even if the seller does not lower the price to the appraisal amount, you could still try to get a discount.
- Pay the lender the price difference: the lenders determine the loan amount with the appraisal. So, if the appraisal is low, the loan amount may be decreased. However, if you still want to purchase the property, you could increase your down payment to cover the difference between the loan amount and purchase price.
- Walk away: this is where the appraisal contingency comes into play. If the seller will not lower the price and you don’t want to pay the difference, the appraisal contingency allows you to revoke the purchase agreement and recover your earnest money.
How Can Sellers Work Around a Low Appraisal?
When selling to a financed buyer, sellers also have several ways to respond to a low appraisal during the closing process.
- Request a copy of the appraisal: if your buyer is willing to share the appraisal with you, review it to ensure it’s factual. It’ll be in the buyer’s hands to ask for a review or to challenge the appraisal, but it may also be in their interest to do so to get the financing they need.
- Ask the buyer to appeal the appraisal: the buyer has the option to challenge the appraisal if they believe it was done poorly or based on inaccurate information or bad comps. You’ll want to pinpoint exactly which parts of the appraisal you think are inaccurate. The buyer would be responsible for paying for the second appraisal and the first, but you can offer to split the cost in good faith.
- Lower the price: the buyer may want the deal to close as much as you do. But a low appraisal may mean a lower loan amount for the financed buyer. So, if they are unwilling to challenge the appraisal or pay the lender the difference between the purchase price and the lower loan amount, you could lower the price to keep the deal together.
- Offer seller financing: if you’re sure your home is worth more than the appraisal, but the buyer is unable or unwilling to pay the difference to the lender, you can offer seller financing for the difference. Of course, this option depends on whether you have the means to do so. But, if you and the buyer do decide to go down this path, you should involve a lawyer in the process.
- Cancel and try again: as we mentioned, spring and early summer are the most competitive times to purchase a home. As a result, demand and, therefore, home prices are higher. So, if you have the option to wait, you can walk away from the deal and relist during a more competitive time or a Seller’s Market. Alternatively, if you originally had multiple offers, you can try again with a different buyer who may be able to pay the difference or whose appraisal might come in higher.
