You did it. It may have taken a few unsuccessful, nail-biting multiple-bid tries to get here. And there may have even been a successful bid that went to contract but was submarined by unresolvable inspection issues. But you are finally in contract on your new house – congratulations!
Dates and details on the contracts are agreed to, the home inspection was done and issues have been addressed, the green light says go and now it is time for the mortgage process to begin.
After careful consideration and much trepidation, you picked a lender and signed all of the application documents. You submitted your bank statements and tax returns and paystubs and every other piece of paper that has anything to do with your mortgage repayment wherewithal. Now you are just waiting for news from your lender about what is happening with the loan approval process. What else do they need? Is everything ok? Is the appraisal done?
The appraisal is just a matter of making sure the house you are buying is worth whatever the number is on your contract where it says purchase price. So while your lender is hard at work making sure all the stuff you told them about where you work, how much money you make and how you have great credit is all true, an appraiser has been deployed to visit your soon-to-be new home.
Why lenders need to know your home's value
The market value of the home you are buying is a pretty important piece of corroborative information for your lender. The house or condo is the collateral the lender holds while you pay back your mortgage loan, so naturally your lender wants to know what it is worth. It is the safety net, the just-in-case back-up, if for whatever reasons all of the credit package evidence and all of the lender’s scrutiny fails to foresee a loan that ends up in default.
But first, the lender wants to know if the house you are buying is worth what you agreed to pay for it because the structure of your mortgage financing will be based on the lesser of the agreed upon purchase price or the appraised value. Take a moment to digest that fact; if the appraisal comes back with a value that is less than the purchase price, the financing will be based on the appraised value, not the purchase price.
For example; if you are buying a $300,000 house with a 10 percent down payment and that house appraises for $290,000, your can only borrow $261,000, not the $270,000 you thought you were getting. Your down payment would increase from $30,000 to $39,000 unless there is an adjustment to the purchase price.
If the appraisal comes back with a value that is more than the purchase price, thank your real estate agent. You got a great deal.
What's in an appraisal
An appraisal report is typically 25 to 30 pages long and it is a detailed, formulaic market analysis of homes in the area that are sort of like the one you are buying. It is fortified with factual data from similar homes recently closed that are characteristically similar to the house being appraised. Time and distance constraints are used as a means to achieve best accuracy so appraisers start by looking for comps (comparable sales) that have closed within the last three months and within a one-mile radius from the subject property. Up and down adjustments are made for differences in characteristics and features between the comps and the property being appraised, and a value determination is rendered.
So what happens when your lender tells you the appraiser came back from visiting your soon-to-be new home and determined that the market value does not support the price you are paying for it? The first thing that usually happens is everybody gets upset. The lender rep gasps and is tasked with being the bearer of the bad tidings, the real estate agents protest and argue for a do-over, the seller says no way and you the buyer are bewildered.
The good news is that you do have options, the viability of which will depend on your particular circumstances.
One option that is not really an option is the one that everybody wants to do first; appeal the appraiser’s determination of value. CU (Collateral Underwriter) is the new sheriff in the appraisal universe and things are different now. Procedurally, once an appraisal is completed, it is uploaded to a Fannie Mae web portal and registered before it even goes to the lender. The CU algorithm reviews the appraisal virtually and attaches a risk score (on a 1 to 5 scale, 1 being low risk, 5 being high risk) to the appraisal, and then the report is delivered to the lender. However significant the rationale may be for appealing an appraiser’s value determination, the chances for successful appeal or a new appraisal authorization are pretty close to never. If the CU risk score is acceptable, the appraisal conversation has for all intents and purposes ended, regardless of how unfair the value may seem.
What to do with a low appraisal
But there are other options depending on your particular circumstances. First of all, you can absolutely count on there being a flurry of phone conversations between the sellers, the real estate agents and possibly attorneys. And there is no doubt the subject of some of those conversations will be the issue of a change in the contract purchase price. If that happens, problem solved. Your lender reconfigures your mortgage financing and everything goes back to green light means go, only now with a reduction in the purchase price!
You could opt out of the deal altogether but that depends on whether the contract you signed will let that happen.
Two options remain if you stay in the deal and the purchase price does not change. First, you can simply pony up more down payment money because your lender has reduced the amount of mortgage financing you are getting. This option assumes, of course, that you have access to more money for the down payment. Second – and this depends on the purchase price, loan amount and loan product parameters – you may be able to reconfigure the mortgage financing based on a smaller down payment. In the $300,000 house example, the lender could reconfigure the mortgage financing with a 7 percent down payment on the $290,000 appraised value ($20,300) and use the remaining $10,000 from your original down payment plans to keep the deal intact. PMI (Private Mortgage Insurance) costs will be higher and you have to be approvable, but it may save the dream.
By the way, if your house does not appraise for the purchase price, that does not mean that it is not worth what you are paying for it, it just means that the appraisal mechanics did not come back with a supporting value. There may be and probably are other purchase deals pending that would help, but they have not closed yet so they don’t count. If it does happen, keep your cool, have lots of communication and remember that everything works out the way it is supposed to work out.
A loanDepot licensed loan officer can help with these and any other lending questions. Call (888) 983-3240 to speak with one today.
Published August 14, 2015
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