Buying a Home → Going Under Contract
Here we’ll share what an appraisal is, how it works, and why you’ll want to consult with your real estate agent and make sure you have a Financing Addendum (aka Appraisal Addendum) to protect the value of your purchase.
What is an Appraisal?
An appraisal is your lender’s estimate of the value of the home you want to purchase. The lender orders this appraisal to confirm that the value is high enough to support the loan that you are getting.
How the Appraisal Effects Affects You
You and your real estate agent will walk through many homes together, find the one of your dreams, make an offer, and negotiate the terms, but ultimately the transaction could fall apart possibly because of a low appraisal value or a conditional repair that needs to be made to the home. In this case, further action must take place between the seller and buyer before the loan can be finalized. Most often, this is outside of your control and could result in the loss of the home purchase.
What Else Can Happen with an Appraisal?
An appraisal can come in “at market value,” “above market value,” “below market value,” and/or with “conditions.”
If an appraisal comes in at the original sales price (aka the market value) or even above it, you and the seller are free to move on to closing. The seller does not get to increase the price to a higher appraised value. This is important because the buyer is only agreeing to pay up to a specific amount (never more than the negotiated amount), which is subject to the lender’s appraisal.
What if the Appraisal Comes in Under Market Value?
If you are using financing to make your purchase, in Washington State you may include a Financing Addendum (or a separate stand-alone Appraisal Addendum, if you are not using financing and you only want an appraisal to confirm value). Use of these addendums will allow you a further negotiation or remedy to address the home’s value should the appraisal come in below value.
For example, if the appraisal comes in lower than the agreed upon price (aka below market value), the seller has the option to either reduce the price to the appraised value, request a reconsideration of value (providing evidence that the appraiser was incorrect), or cancel the contract and return your earnest money.
However, other alternative remedies exist, such as the buyer having the option to pay the difference in cash between the agreed upon price or the low appraised amount. Or, the buyer and seller can agree upon some other remedy in between.
The bottom line is that the lender will not loan on the home at a value above the appraised price. And, the appraiser may not agree to adjust the appraisal, even with proof of value. If this happens, you may have already paid for this appraisal and it is of no value to you if you do not complete the purchase.
Other Options or Considerations
In the case of a low appraisal, if you are unable to reach an agreement between the seller or the appraiser (such as a reassessment of value) you would have the option, if using a Financing Addendum, to rescind (cancel) the contract, and you would have your earnest money refunded to you if you have met the criteria of the agreement.
If appropriate and approved by the lender, the buyer can always agree to pay the difference in cash between the purchase price and the low appraised value. The agreement is put into writing and you would proceed toward closing on the home.
If repairs are required by the lender (or called for on an appraisal report) the repairs must be completed before closing at the seller’s expense. The seller, again, has the option to reject those repairs, which could cancel the contract and return the earnest money to the buyer.
A few examples of the conditions that could come up (or be called out by the appraiser) in an appraisal could be:
- Roof condition (may need a new roof or a certification)
- Flooring condition
- Paint condition
- Broken glass
- Non-operable appliances
- Unsafe conditions
- Smoke detectors
…and much more. Any conditions that would make the home unfinanceable and require repair to meet the appraisal or loan guidelines are applicable here.
Furthermore, if the seller refuses to make the conditional repairs, the buyer and seller could agree that the buyer could make repairs if they are required. This is a very risky option because (a) you are repairing a home you do not own (things could go wrong and if you do not close, you have no remedy to recover any expense), or (b) it would be risky for the seller to allow a buyer to perform repairs on a home that they do not yet own. If you do not complete the sale, then the seller is stuck with something they may not have wanted. Neither of these options are recommended because of the high risk associated with them.
Here’s a great example of this last example:
Let’s say a home is in need of a new roof, and the seller was purposefully selling the home below market value because they knew they could not make any repairs to the home, and they knew the roof could be an issue. A buyer might think they’re getting a great price for the home, and they’re willing to take care of the roofing later. The buyer and seller might enter into an agreement, but the appraiser might make a new roof a condition of the appraisal, and therefore the new roof would need to be done BEFORE closing. If the seller doesn’t have funds to do the roof and the buyer can’t get the loan to make the purchase without the new roof… what happens next? Does the buyer really want to take the risk of installing a roof out of pocket on a home that they don’t own? And why would a seller allow a buyer to put a roof on their home? Even if the buyer intends to purchase the home, the deal might fall through, and the seller might be left with a poorly done or incompleted roof. risking poor workmanship or an unfinished product.
Learn more about appraisals by watching this informational and entertaining video here!