A real estate appraisal or a property appraisal is a process in which the actual market value of a property is determined by third-party, non-biased professionals called appraisers.
The actual market value of the property is different from the price the seller wants or the price a buyer is willing to pay. It’s what the bank or the mortgage lender considers the real value of the property and uses it to calculate the loan amount. The property can be any type of real estate whether it’s residential (condos, coops etc.) or commercial (retail shops, offices, etc.). Appraisers are professionals who know how to calculate the price of a property at a specific time. They are unbiased, so they don’t come up with a value that intentionally benefits the buyer or the seller.
It’s important to note that an appraisal usually has a short expiration date. Some appraisals are valid for up to six months; others are valid for only three months. That’s because changing market conditions may affect the value of the property.
Appraisers, the professionals tasked with appraising the property and coming up with a fair market value for it, look at two main aspects:
2. Similar properties sold in the vicinity, also known as comparable or “comps” for short
In the property, they look at things like its size, condition, age, location, neighborhood, etc. Newer and improved properties might sell for a higher price than worn down or older properties. The location, such as how close a property is to a subway station or a large food market, can also influence its price.
Recently sold properties make for better comps because they offer appraisers the “freshest” idea of the market. The more comps there are, the better and more accurate the appraisal is likely to be.
A property appraisal is for the bank and/or the mortgage lender. The bank wants to make sure that the money they give to the homebuyer, or borrower, is secure. They don’t issue the loan for any more than the property is worth so that if it comes to selling the property to recover their losses, they don’t lose any money.
The appraisal is done before finalizing the mortgage and usually after the buyer and the seller have negotiated a price since most banks need a fully executed contract prior to scheduling it.
The homebuyer (who is also the borrower) pays for the appraisal. Once the bank has the appraisal report, they determine how much mortgage loan they will issue, using something called Loan-To-Value or LTV.
A Loan-To-Value (LTV) is the ratio of how much loan you are taking from the bank and what your property is valued at. For example, if the appraised value (and the final selling price) of a property is $1,000,000, and you’ve saved up 20% or $200,000 for the down payment, you’ll need to borrow $800,000 (loan value). Your LTV would be:
Loan-To-Value = Loan Value/Appraised Value = $800,000/$1,000,000 = 0.8
Since you assume a decent amount of risk by paying for one-fifth (20%) of the property yourself, the bank might give you a lower interest rate. If your LTV is higher around 90%, where you are only paying for 10% of the property, the mortgage interest rate will most likely be higher. And you might also be required to pay for Private Mortgage Insurance or PMI. In addition, it can be more difficult to find a building that allows only 10 percent down in NYC. Coops will not allow less than 20 percent.
Other facts, like your credit score and history, impact your interest rate, but LTV also plays an important role. Also, some banks (mortgage lenders) might have specific LTV cut-offs for different properties (like co-ops, condos, etc.). And you might not be able to take more than a certain portion of your property’s appraised value (like 80%) as a loan.
Yes you can waive the property appraisal if you are paying all cash and not taking out a loan. But, when a mortgage lender is involved, this isn’t possible. An appraisal is compulsory before they can underwrite and process a mortgage loan.
A low appraisal is when an appraiser determines that the property is worth less than what you’ve agreed to buy it for. If it’s a minor difference, it’s easy to cover with your down payment. But if the difference is significant, you may negotiate the price down, get another appraisal, or challenge the appraisal after conducting your own research. If you have an appraisal contingency, depending on the terms of your deal, you may be able to legally back out of the transaction without any penalty.