A mortgage is necessary in the vast majority of real estate transactions in this country. The buyer puts a certain amount of money ‘down’ and then borrows the remaining balance from a lending institution. The lending institution then issues a mortgage to the buyer using the house as collateral. In order to establish the value of the house (collateral), the bank will send out an appraiser. The appraiser will inspect the home; do research on the homes like it that have recently sold in the area and report back to the bank whatever it deems to be the value of the house. The bank must feel comfortable that the value is strong enough to justify using the home as collateral for the loan.
The appraisal process can be much more difficult in the current environment than it has been in the past for two reasons:
1.) More mortgages are becoming delinquent.
The value of the collateral has always been important. The other major consideration of the bank when making a loan was the borrowers’ previous credit history. If the borrower could show a history of always paying their bills on time, the bank would have less concern about having to take the home back in a potential foreclosure action for non-payment. The collateral would then be less of an issue in the bank’s mind.
The number of people defaulting on their mortgage payments is currently ten times greater than historical levels. Some borrowers are even ‘walking away’ from their mortgage obligation even if they have the financial resources to pay. There is currently a greater chance that the bank will have to foreclose on a loan. That makes the appraised value of the home (the collateral behind the loan) more important. We have seen banks become more conservative with appraisals because of this.
2.) The ‘mix’ of homes used to establish value has changed.
There were very few distressed property sales (foreclosure or short sales) five years ago. Distressed properties make up over twenty five percent of all homes sold today. The homes used as comparables by appraisers to establish value today reflect this change. More and more distressed properties are entering the ‘mix’ of properties being used as comparables. The distressed properties sell for less. The result is lowered appraisal values when they are used as comparables.
Should an appraiser even consider distressed properties when establishing the value of a non-distressed property? There is much debate on this issue. We must realize that the reason the bank is doing an appraisal in the first place is to protect the loan they are making to the borrower. The house is the collateral to that loan. If the borrower fails to make payments, what will the bank be left with – A FORECLOSURE! With that in mind, the bank can make a reasonable argument that distressed properties should be considered.
What does this mean to you?
If you are a buyer…
Realize that only you know what the true value of the home is to you and your family. You have probably shopped online and seen 100’s of homes. You then picked out the ones you thought were best and visited them. You went into every room and saw every amenity. After scrutinizing all these homes, you picked out the one that best fit the needs and goals of your family. You agreed on what you believed to be a fair price. Don’t allow the appraisal to convince you that you were wrong. The report was done in just a few days (or even hours) and was completed to satisfy the banks current need to be conservative.
Be willing to revisit the price of the home and see whether the difference can somehow be negotiated.
If you are the seller…
Realize you are selling your house at a time when banks are being conservative on values. If your appraisal does not come in, do not be quick to ‘kill the deal’. There is no guarantee that you will find another purchaser. There is no guarantee that a new buyer will match the offer the previous buyers made and, even if they do, there is no guarantee that you won’t have the same challenge with a new appraisal.
Think hard and long and see if perhaps you can re-negotiate a deal that both you and the buyer can live with.
Courtesy of Dana Hinson of Benchmark Mortgage