Real Estate Appraisals - An Awkward Piece in the Homebuying Process
Friday, July 6th, 2007If you’ve ever purchased a home before you’ve probably taken out a loan (mortgage) to finance at least part of the purchase. In doing so you were probably told that the bank would order an appraisal of the property. The purpose of the appraisal is to make sure the property is not being purchased for far more than its true market value, thus endangering the bank’s ability to sell the property should you, the borrower, not be able to repay the loan. On the other hand, the bank would not care in the least bit if the property was worth more than the sale price, or in cases where there is a significant downpayment the bank would not care to any greater degree than the amount that they had loaned you.
While it may sound like the appraisal is an excellent tool to help protect you, the buyer, there are several problems with how the appraisal process works that I want to alert you to:
1. The appraiser works for the bank, not you. I find it rather funny that you don’t see appraisers assigning a home value that is ever higher than the sale price. This is a flaw that assumes the market price (the price that you the buyer have agreed to pay to purchase the home) is always the correct price.
It therefore ignores the fact that sometimes people pay too much or sellers charge too little for the property. It assumes the market is ALWAYS correct in the price of a property and that every transaction is at arms-length. If the sellers are not very sophisticated and the buyers realize that the property has a greater value than is being sold for, the sale price does not truly reflect what the appraised value should be.
Why is this problem important to you as a buyer? If the bank requires you to put down say 10% or 20% in order to qualify for the loan… and let’s say the contract sale price states $100,000 - you would need either $10,000 or $20,000 for a downpayment. Let’s stick with the 10% for simplicity sake. If the property’s true value is believed to be $125,000 and you have a contract to purchase it at $100,000 then you already have $25,000 of equity the day that the sale of the property changes hands (closes). $25,000 is 20% equity in a $125,000 property, but the bank is requiring you to tie up an additional $20,000 of your own money as a downpayment. If you meet the equity requirement you shouldn’t be forced to tie up additional money as equity in the property.
2. The appraiser knows the contract sale price and terms before doing the appraisal. This builds off of the previous problem… in # 1 above we saw that the appraisal typically does not come in higher than the sale price, but rather right at the sale price. You will NEVER be able to convince me that the appraiser is being objective in his or her reporting of the property value if the contract sale price and terms are known in advance of doing the appraisal.
To truly be objective, the appraiser should not be told the contract terms and price and be left to find comparable properties and recent sales as well as calculating other methods of value such as the income approach for rental/income producing properties and construction replacement costs for buildings that are being used for other purposes than they were orginally constructed.
3. The appraisal is only the opinion of ONE person. If I went out to buy a car, or to buy insurance, or even to buy groceries… I am going to look around and shop around. For a car, I am going to visit multiple dealerships, use multiple car valuation sources (like NADA, Kelly Blue Book, Edmonds, etc) and same is true for insurance… I am going to get multiple opinions before I make the purchase. With an appraisal you are getting ONE person’s estimate of the property’s value. To be truly objective you should take # 2 above, the appraiser not knowing the sale price and terms… and add to it, by having more than one appraiser calculate a value and then compare the two (or more) appraisers’ reports and how they came up with their values.
I know this may seem like I am taking a small portion of the home buying process, but people rely on these appraisals to keep them from being taken advantage of and from getting in over their heads. This is far more common place in refinances, where it’s just you and the bank… no seller involved. The bank has every incentive to use an appraiser that is more likely to inflate the value in a refinancing situation so that they can make you a bigger loan during the refinancing process… a bigger loan that might translate into you never being able to sell the house or property and recoup your loan amount.
Yahoo! Finance recently posted an article about this very topic and I thought it was appropriate to end this blog post with a link to the article. I think as loan interest rates go up and therefore adjustable rate mortgages (referred to as ARMs or ARM loans) become more expensive, you will see more people going into foreclosure on their home loans and this issue will be receiving more attention in the media and by state legislatures and Congress. The Yahoo! Finance article is entitled Appraiser Coercion Fuels Mortgage Fraud.
When you go to buy a property you need a certain level of trust with your Realtor, your lender, and you need to feel comfortable that you are getting a good value for your money. If you don’t feel comfortable, by all means walk away from the deal before you get locked into a contract… or hire your own independent appraiser before you agree to a price or any other contract terms. A typical appraisal won’t cost you more than $200 to $400 and when you are thinking of spending hundreds of thousands of dollars, that $200 independent appraisal could very easily save you far more in the future.
As always, I welcome your comments and feedback…
