What is an appraisal?
Updated March 31, 2022
An appraisal, or home valuation, is the estimated value of a home by a licensed professional appraiser who visits the home for a thorough inspection and then compares it with recently sold homes in the area and current market trends to determine its value.
The findings from an appraisal report help to determine how much a mortgage lender will allow a home buyer to borrow to finance or refinance, the purchase of a home. Appraisals protect the lender from giving the buyer more money than the home is worth. If the borrower defaults on the mortgage and the property goes into foreclosure, the lender will sell the property to recoup the money it lent to the buyer. In such a scenario, the appraisal protects the lender from giving the home buyer more money than it can recover.
Appraisals are done by licensed third-party appraisers who have no connection to the buyer, seller or lender. The appraiser should have local knowledge of the area, and is expected to follow the Uniform Standards of Professional Appraisal Practice issued by the Appraisal Foundation, a professional organization.
Appraisals are done by licensed third-party appraisers who have no connection to the buyer, seller or lender. Credit: Jason Briscoe/Unsplash
In real estate transactions, appraisals are ordered by the lender after a contract is signed to determine whether the contracted price is appropriate given the home’s location, condition and amenities. The lender will often turn to a neutral third party, an appraisal management company (AMC), to arrange for the appraisal, but many banks in small local markets often have direct referral arrangements with a handful of individual appraisers and will bypass using an AMC.
Some lenders also have in-house independent appraisal departments. Once an appraisal is ordered, it is usually the seller’s real estate agent who arranges the scheduling with the appraiser. Appraisals typically cost several hundred dollars, depending on the local market, and these appraisal fees are usually paid by the buyer as part of the closing costs charged by the lender.
In their on-site review of a home, which typically takes 30 to 60 minutes, appraisers thoroughly inspect the home’s interior and exterior and note any conditions such as a leaky roof, cracks in the foundation and other needed repairs that adversely affect the value of the property. They also look at the home’s square footage, its bedroom and bathroom count, how well its floor plan works and the age of plumbing and other systems, along with improvements such as new windows, an updated kitchen or a garage addition.
This is similar to what a professional home inspector does in writing up a home inspection report, but there are a few key differences. In general, an appraisal assesses the value of the home, for the lender, while the home inspection report assesses in great detail the actual condition of the property, for the prospective homeowner (the buyer).The home inspection is ordered and paid for by the buyer immediately after a final price is agreed upon with the seller. The inspection comes before an actual contract between the buyer and the seller is signed, and if major problems are uncovered by the home inspector the buyer is free to walk away from the deal.
For home buyers, the appraisal report, along with the home inspection report, is one of the first steps in the closing process. If the appraised value comes in at or above the agreed upon price of the home, the sale should proceed normally.
Problems arise, however, when the appraisal is below the contracted price, possibly delaying or even canceling the transaction. Keep in mind that lenders generally base the amount of money they will lend to a buyer on the appraised value of the property, not the listing price.
When the appraisal comes in below the contracted price, the bank will likely require the buyer to increase the down payment to make up the difference between the new appraised value and the contracted price. Or a low appraisal can be used as a negotiating tool to get the seller to lower the price.