Appraisals are essential in the real estate market as they determine the value of a property before any mortgage or refinancing transaction is initiated. However, the situation can become daunting when a home appraises below the agreed-upon purchase price. A low appraisal can impact the financing process and potentially delay or even jeopardize the closing of a property deal.

In this article, we will delve into the reasons behind low appraisals, the challenges they may pose, and the strategies buyers and sellers can employ to navigate this situation successfully. Understanding the appraisal process and being prepared with contingency plans can help ensure a smoother real estate transaction and prevent the frustration of dealing with a low home appraisal .

What Does A Low Appraisal Mean?

When the appraisal of a property results in a value lower than the mutually agreed purchase price between the buyer and seller, it is known as a low appraisal. The appraisal serves as a snapshot of the appraiser's assessment of the property's current market value, drawing from comparable closed sales in the vicinity.

A low appraisal can affect the financing process, as the lender bases the loan on the appraised value. This limitation in financing may lead to delays or even pose a risk of derailing the closing.

Despite the concerns that arise from a low appraisal, it is essential to remember that real estate agents have the skills to assist in managing the appraisal process. With their guidance, buyers, and sellers can navigate this situation effectively, ensuring a smooth progression towards a successful closing.

How Do Appraisals Work?

Understanding how appraisals work is essential when finalizing a new mortgage or refinancing. Banks order home appraisals to determine the property's value. The appraiser evaluates the property and compares it with recent sales in the area. Subsequently, the appraiser prepares a detailed report expressing their professional opinion on the property's value.

The estimated value of a home may differ from its actual price, either higher or lower. Mortgage lenders typically only lend up to the appraisal price in a home sale if it is lower. This precaution ensures that, in the event of a default, it is possible to recoup the potential loss on the loan.

What Causes a Low Appraisal?

A low appraisal can happen for various reasons, often related to the housing market and the appraisal process.

Market Factors

One significant factor contributing to low appraisals is the state of the housing market. Artificially inflated prices can occur due to multiple offers and competitive bidding. Conversely, a decrease in home values can result from a surplus of homes in the market compared to fewer buyers. On the other hand, market values may rise when there is a high demand for housing, but the supply is limited.

Inexperienced Appraisers

Occasionally, a low appraisal can be due to an inexperienced appraiser who may need to grasp the local factors influencing property values fully. However, it is worth noting that such occurrences are infrequent, thanks to internal review processes and regulations implemented under the Home Valuation Code of Conduct (HVCC) .

Overlooking Relevant Data

Appraisers might inadvertently overlook pending sale data, which could reflect higher comparable sales once those transactions have concluded. Additionally, they might mistakenly choose similar deals from the wrong neighborhoods, which can impact the accuracy of the appraisal.

Other Factors

Other reasons for a low appraisal include potential errors the underwriter made during the evaluation process or the seller overpricing the property. Sometimes, sellers might set their prices based on the amount they initially paid for the property or its sentimental value.

It's crucial to understand that a lender's decision to provide a loan does not solely depend on whether they want to lend money. Lenders are motivated by the desire to settle loans as it is how they generate revenue. Moreover, lenders must refrain from using redlining practices, where they discriminate against certain geographic areas by refusing to provide loans in those regions.

If the Appraisal is Less Than the Purchase Price, What Happens?

When an appraisal indicates a value lower than the agreed-upon purchase price of a property, it can negatively impact both the buyer and the seller. A low appraisal means a buyer's mortgage lender will not provide a loan exceeding the appraised value.

Loan guidelines require lenders to calculate loan-to-value ratios based on appraised values. Let's illustrate this with an example: Suppose you are using a conventional loan to finance a $200,000 house, and the maximum LTV for this loan is 97%, which amounts to $194,000. If the home appraises for only $190,000, you must find a way to cover the $10,000 difference.

What Should I Do if I Receive a Low Appraisal When Refinancing My Home Loan?

When refinancing  a home loan, encountering a low appraisal is relatively less common than when a lender appraises a home for purchase. During the refinancing process, the lender's primary focus lies in evaluating the equity you possess in your home and your history of consistently making timely and complete monthly mortgage payments.

What To Do About A Low Appraisal

Handling a low appraisal can be challenging, especially when sellers and buyers have conflicting goals. Sellers naturally want the top dollar for their property, while buyers seek to avoid overpaying. Additionally, there's the complication of potential lenders who may not finance a mortgage for an amount exceeding the home's appraised value.

Here are some strategies to consider when faced with a low appraisal:

1. Make Up the Difference in Cash

If you have enough money, you can fill the difference between the estimated value and the agreed sales price by providing extra cash. Lenders primarily focus on the loan-to-value ratio, which represents the percentage of the home's value covered by the mortgage. A low appraisal doesn't automatically imply that the lender will decline the loan; instead, they typically base the loan amount on the ratio specified in the contract, aligned with the appraised value.

2. Reduce the Price

One of the most common and effective solutions is for the seller to adjust the property's price to align with the appraised value. This approach often satisfies both the buyer and the lender. In some cases, sellers might need to close the sale in a buyer's market, making a price reduction a practical choice.

3. Dispute or Request a Second Appraisal

As a seller, you can request a copy of the appraisal report from the buyer and inquire about their dispute practices. However, the appraiser cannot directly communicate with the seller or agent. The lender is typically the party authorized to order a second appraisal, which may or may not be approved. If you're the seller, you can offer to share the cost of the second appraisal.

4. Provide Comparable Sales Data

Gather recent data on comparable sales that support the agreed-upon sale price and submit it to the underwriter, requesting a review of the appraisal. Using similarly situated sales closer to the subject property's location can strengthen your case.

5. Consult Pending Sales

Your agents can inquire about the sale prices of pending properties that have yet to close. Although listing agents aren't obligated to disclose sale prices, many are willing to help. This information can offer valuable insights into possible changes to the appraisal.

6. Find Middle Ground

In certain situations, sellers may be willing to compromise and lower the price to meet buyers halfway between the sales price and the appraised value. This middle-ground approach can facilitate a smoother negotiation.

7. Cancel the Transaction

If you included loan contingencies in the purchase contract and the appraisal is low, you can withdraw from the agreement without incurring penalties. A properly written loan contingency allows for contract cancellation if financing is not possible based on the agreed-upon terms. The seller will then need to return the buyer's earnest money deposit.

Remember that if a low appraisal occurs, the seller might relist the property and seek a new buyer. A subsequent appraisal might yield different results, mainly if it's not an FHA appraisal that utilizes case numbers and allows reusability for multiple buyers.

Navigating a low appraisal situation requires open communication between all parties involved, including real estate agents and lenders, to find the best resolution for a successful transaction.

Tips to Prevent a Low Appraisal

While low appraisals are relatively rare, it's essential to be prepared for such a scenario to avoid surprises during the process. Being ready can help ensure a smooth transaction without setbacks, whether you're a seller or a buyer. Here are some valuable tips to consider for both sellers and buyers:

Tips for Sellers:

• Ensure the Home is Presentable: Prioritize preparing the interior and exterior of the home to make a positive impression on the appraiser.
• Be Ready to Provide Information: Be prepared to answer any queries the appraiser may have about the property.
• Document Upgrades: Keep a comprehensive list of all home upgrades and renovations, including their corresponding completion dates.

Tips for Buyers:

• Make a Thoughtful Offer: Be strategic when placing your initial bid on a property to avoid potential appraisal issues in the future.
• Carefully Review the Appraisal: Thoroughly assess the appraisal report to understand its implications and any possible discrepancies.
• Inquire About a Second Appraisal: Discuss with your lender the possibility of ordering a second appraisal if you believe the first one needs to be revised.
• Negotiate if Needed: If the appraisal comes in low, consider negotiating with the seller to reach a fair agreement on the purchase price.
• Be Prepared with Additional Funds: Have cash available for closing if the appraisal value is lower than expected.
• Consider an All-Cash Offer: In certain situations, an all-cash offer may increase your chances of securing the property.

To ensure a smooth real estate transaction, sellers and buyers can benefit from these tips on navigating the appraisal process effectively. Following these guidelines will increase the chances of a successful deal.

The Bottom Line: Exploring Your Options with a Low Appraisal

The home-buying process involves numerous elements that need careful consideration. Among these, home appraisal plays a crucial role. Although low appraisals can lead to delays, you can address these challenges effectively by collaborating with your real estate agent and lender. This way, you can navigate past these situations and eventually reach the closing stage of your property purchase.