How Low Appraisals Work
First of all, some people think you will automatically get an appraisal when you buy real estate. However, you only need an appraisal when you are getting a loan. The lender needs to know the property's value. Meaning - appraisals aren't only about money - sometimes they are about repair work as well.
The loan amount is based on the appraised value. The lender will not loan an amount higher than the appraised value.
In our hot real estate market, where people are outbidding each other to win the house - the offers might escalate the price above the appraised value. Of course, you won't know that until later in the process. In the moment, you are just estatic that you've won the offer in this competitve market.
During the lending process, the lender will put in an order for an appraiser to view and evaluate the home. The appraiser produces a report that real estate agents don't normally look at. If a home is valued at the price that is needed for the loan, there is no issue and no reason to review an appraisal report. Everyone can breathe a sigh of relief, and move forward with the transaction.
However, if the apprasier evaluates the home and decides that the value is less than the sales price, that's a different story.
Here's the basic process:
Buyer's agent notifies the seller's agent of low appraisal.
The seller can respond several different ways:
The seller can agree to the lower sales price.
The seller can ask for a reconsideration of the value/get the home re-appraised (lender must approve).
The seller can propose a reduction in price (often times, seller proposes that the seller and buyer split the cost of the low appraisal).
The seller can reject the low appraisal (essentially rejecting the entire deal).
The buyer can respond several different ways:
Give notice to terminate the agreement (and they will get their earnest money returned).
Waive financing contingeny (oftentimes if seller doesn't want to reduce the price, the seller asks the buyer to pay the full difference and asks the buyer to waive the financing contingency).
Accept reduced purchase price (where the seller and buyer usually split the cost of the low appraisal - not always 50/50 - that part is negotiable).
Let's use an example.
Original Purchase Price: $550,000.
Low Appraisal Price: $540,000 with Repairs "Subject To".
Buyer's agent notifies seller's agent of low appraisal.
Seller decides he will take option of a proposed reduction in price.
Seller Requested Action: Offer reduced price of $545,000 and to complete repairs "Subject to" **
Buyer accepts seller's reduced price, which means buyer will need to bring more money to closing.
Seller completes repairs listed in appraisal report.
Lender notifies appraiser of repairs.
Appraiser re-evaluates repairs to verify work completed.
Move on to closing.
** Repairs "Subject To" means that the appraised value is subject to the repairs. The repairs must be completed to get the appraised value. If you see "As Is" that means the appraiser may notate a repair needed, but that the value is the same whether or not repairs are completed.
Note: If your buyer is asked to help pay for the difference because of a low appraisal, contact the lender to find out what the true gap is. It may not be as high as you think. If the purchase price is lower, so is the down payment. The difference between the down payment amounts will cover some of the difference of the low appraisal price.
Finally, remember the low appraisal is an emotional process for all involved.
The buyer may begin to question if they overbid on the home.
The seller often feels their home is worth more than what the appraiser is valuing their home at. The real estate market dictates the monetary value, not the sentimental value. After all, this is the home that they have lived their life. This is the home that they put so much time and effort in. There is value to that, no doubt. But it's a different kind of value.
It's our job as the real estate professional to understand the contingencies, know how to handle the contract and advocate for our clients. The client's best interests are of the utmost importance.
Kristin Bushnell is Designated Broker of Bushnell Real Estate Solutions and Co-owner of Bushnell Craft Brewing Company in Redmond, WA. Check out my profile here.
If you are ever interested in chatting about real estate, contact me at firstname.lastname@example.org or call me at 425-559-1355. I'll buy you a beer (or non-alcoholic beverage, if you prefer!), and we can chat about real estate until your heart's content.