When an appraisal comes in low

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Luckily this hasn’t happened often to me…last week we closed a transaction where the appraised value came in lower than the agreed sales price on the purchase and sale agreement.   Ugh!

The property is a nice home in south King County that was originally listed for $275,000. Shortly after going on the market, a bidding war commences and my client “wins” the home after it is bid up to $300,000 which includes building in $6,000 of closing costs to be paid from the seller.  My client is putting zero down into the transaction (100% loan to value).

The appraiser is faced with many challenges in this scenario.

  • How can he justify the significantly higher sales price over the list price?
  • Finding like properties, also referred to as “comps” or “comparables” (a small split entries with similar square footage of 700 on the main floor) that have recently sold and closed.
  • Finding these comps within a radius close to the subject home.
  • Stacking in a significant amount of closing costs into the sales price.

From the appraiser’s point of view:

“It’s a touchy issue because a sales price over and above the listing price is difficult to deal with.   If you look at it objectively, why would anyone pay over the listed price in the absence of a bidding war, especially if the property has been on the market more than a couple of weeks.   If it was worth more than the listed price, one would think it would have sold right away.   In the present environment (sub-prime problems) the appraisal is getting scrutinized more than ever before.   This makes the adding on closing costs issue harder and harder to deal with.”

The home in this scenario appraised for $285,000.  So what happens next?   When it comes to determining the value of a property, the lender is going to use the lesser of the sales price or appraised value.   If the home would have appraised for $320,000; the lender would use $300,000 for the value; with the home appraising for $285,000 this is now what the lender will base the loan on when factoring loan to values.

The buyer has a couple of options from the lender’s standpoint.

  1. The sales price can be reduced to the appraised value of $285,000.   Since this loan was 100% financing, the loan amount was also reduced to $285,000.   If the loan amount was not based on 100% of the value, the loan can be restructured.   For example, if the buyer was planning on putting 20% down on a $300,000 home, their loan amount would have been $240,000.   Now with a value of $285,000 their new loan to value is 84%.   The buyer either reduce their loan amount to $228,000 to keep the same program and pricing that an 80% ltv loan would have, or they can opt for a different program (such as PMI or do a piggy back mortgage) with the 84% loan to value.  The loan would be repriced accordingly.
  2. The buyer can bring in cash to make up the difference.    If the seller will not reduce the price to the appraised value, and the buyer still really wants that home, the buyer can bring in the difference between the appraised value and sales price, in this case $15,000.   The loan amount would remain $285,000.   The $15,000 (difference between the sales price and appraised value) would need to be sourced and seasoned.
  3. The buyer (or seller) can decide to not close the transaction.   Depending on how the purchase and sale agreement is written and what contingencies have been removed, the buyer may or may not receive their earnest money deposit back in this scenario.

In this case, the seller agreed to lower the price to the appraised value (it was still more than what they had listed the home for even after factoring in the seller paid closing costs).   The buyer wound up with a lower sales price and lower mortgage payments.

Just because a buyer is willing to pay a certain amount for a home, does not mean that the lender will finance it based on the purchase and sale agreement.   Not all appraisals come in “at value”.   Often they may be a little above the sales price and once in every blue moon, they even come in lower.

Comments

  1. You’re right, Rhonda, we haven’t thought too much about appraisals lately.

    I’m actually a little surprised that the appraiser didn’t come in at $294 (backing off the $6,000 closing costs.) A short market time and others bidding indicates market. Is this a conventional loan or FHA/VA?

    List price shouldn’t have all that much to do with what an appraiser comes in with. An agent may miss- price a house (erroneously), or purposefully underprice a house. I recently (on purpose) listed a house $15,000 under a recent Seller’s appraisal to solicit multiple offers as I had a very difficult tennant. We got 5 quick offers and it sold for $25,000 over the list ($10,000 over previous appraisal)…..and it appraised at value. (All 5 offers were within $5,000 of each other).

  2. Hi Greg, this was a conventional loan with 100% financing that was difficult to find supporting comps. I would bet that the difference between your property and this one was supporting comps. This is a smaller split entry home in south King County. Even after enlisting the agents for help with comps, the appraiser came up with the value of $285,000. I believe the home is probably not truly worth $294,000. Another home, like your listing, may have more comps and could support the bidding war. They bid up this house almost 10% over the list price. What was the list price of your home?

    I did ask for a second opinion on the appraisal (to help provide some ease for the parties involved) and the other appraiser confirmed the value of $285,000.

  3. Who does the appraiser work for? I’ve heard stories of appraisers who don’t meet sales prices being blacklisted by whoever hires them. But it seems to me the appraiser should be working for the lender so that the lender can be assurred of having good collateral against the money they are loaning out.

    How do business that buy existing loans estimate risk? If the originating lender hired a ‘bad’ inspector, the next business that buys the loan could get stuck with an underwater loan. Reinspecting the house and checking the credit and income of the borrower again seems like it would heavily eat into profits (and some of that information might be nearly impossible to verify after the loan has already closed).

  4. Alan, the appraisal is provided for the lender’s purposes. Sometimes a lender may elect to do an AVM (automated appraisal) which cost around $20, in order to make sure the value by the appraiser is in line. Lenders also have “approved appraiser” lists. If a loan goes bad, the appraiser is one of the first things that are reviewed with a fine tooth comb. If a Lender notices a pattern of such with an appraiser, they are removed from the “approved list”, which would be the same as a “black list”.

    Rechecking credit does not happen often unless the existing credit report has expired or if the lender decides they want to. Reverifying information is more affordable than having a loan come back to the lender.

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  1. […] you waive the appraisal contingency, you are at risk for a low appraisal or the appraiser calling for items to be repaired. Even if the home had mulitiple offers, it still […]

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