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In today’s highly competitive housing market with scarce supply, buyers around the country are finding that the only way to win a bid on a house is to go all out, often paying well above the home’s appraised value.
On the surface, this might seem like a risky move. You’re essentially starting with negative equity, which slows your ability to build equity in the house that can be used to refinance your mortgage or get a home equity line of credit (HELOC) down the road—not to mention selling the house without taking a hit to your wallet. But, there can be some instances where paying above the appraised value makes sense.
To help you decide whether paying above an appraised value is really worth it, we’ll dig into what appraisals are based on; when you should back away if a house is selling above its value; and when it’s OK to pay more than what it’s deemed “worth.”
How Appraisers Determine Market Value
What the seller, buyer and appraiser consider the “value” of a house can be vastly different. The seller is likely to focus on all of the benefits of the house to drive a higher sales price. The buyer is more likely to pick out the problems to negotiate a lower price. And the appraiser is meant to be the neutral party to determine the actual market value of the home.
The appraiser’s job is critical as it protects both buyers and lenders from paying more than the market value, and they must comply with regulatory standards. To determine the market value, appraisers typically follow the Uniform Standards of Professional Appraisal Practice (USPAP) guidelines. These guidelines include evaluating the house itself, such as checking out the general condition and evaluating any upgrades, the neighborhood and comparable sales.
Appraisers usually refer to sales within the past few months, but with home prices rising so quickly this past year, they’re looking at more recent sales to get a real-time picture of the market.
“Traditionally, we looked at homes that sold three to four months ago. That always worked well. But now, we have to look at what’s going on today, what’s under contract (and) what sold last week,” says Mary Davis, a licensed appraiser at C. Howard Davis Appraisals in Memphis, Tennessee.
The appraiser can change the appraised value of the property if the market changes. The type of changes that affect the real estate market could be anything from mortgage rates spiking to a natural disaster.
To change an appraisal based on outside influences, appraisers have to create a detailed analysis of why there’s been a material change and what caused it.
Because the appraisal is so integral to securing financing, real estate agents, sellers and buyers can get frustrated if the appraisal comes in low, especially if an equivalent home in the surrounding area has sold for what your home is listed at.
However, just because one buyer paid over the appraised value for a home in your area doesn’t prove that the market value has gone up. This sale could be an outlier, which is why appraisers have to look at several comps to establish value, says Karen Mann, an appraiser at Mann and Associates in Discovery Bay, California.
Another issue appraisers run into is renovated houses that have “over improvements,” which means that the home’s upgrades are excessive for the neighborhood. This is also known as functional obsolescence.
Usually, upgrades that fall into this category don’t count toward the value of the home. A good example is a home with a pool; if it’s the only pool home in a 5-mile radius, then that feature probably won’t be included in the appraised value.
Signs That You Shouldn’t Spend More Than Appraised Value
In a competitive housing market, it can be easy to get caught up in bidding wars and even the fear that you’ll somehow miss out on owning a house. And if you keep putting in offers that are rejected, it might feel like you have to push even harder to snag a home.
Pressure to get a house in today’s market has led people to surrender necessary contingencies designed to protect them and pay more than the appraised value. These can be risky tactics to make an offer stand out. It’s critical that you consider your budget and goals carefully, so you can avoid making a very expensive long-term mistake.
There are several factors you should consider before you pay over the value of the home.
- Actual affordability. The first, and perhaps most obvious one, is can you afford it? If the appraisal comes in low, then you’ll have to make up the difference out of pocket. If that leaves you with an empty savings account and no safety net, this is not the healthiest for you financially.
- Consider when you plan to sell the home. The other affordability issue comes in if you have to pony up the cash to sell your home sooner than expected. The closing costs to sell a home can run into the thousands of dollars. So if you pay more than the value, this could make it expensive to sell if you’re not in the home long enough to gain sufficient equity. If you sell the house in less than five years, you’re taking a significant risk since the value might not catch up with what you paid.
- Is it true love? Finally, be honest with yourself about how much you like this home. If this is not your dream home and you’re buying out of fear or desperation, you could quickly find yourself with a case of buyer’s remorse. And selling a house that costs more than it’s worth takes time and money.
“Even if you do make up the amount in equity, the selling costs will quickly erode any gains, and you may be left with a loss,” says Nikki Gonzales, partner at Adeline Homes LLC, in Waco, Texas.
When to Pay More Than the Appraised Value
Housing inventory is at record-low levels and many homeowners are not as willing to sell, so buyers are left with slim pickings. What is available is often very expensive, and coveted by many other eager buyers.
So what happens when your dream home comes up for sale, and the price is above the appraised value? Some experts say it’s OK to pay above the market price if the following boxes are ticked:
- First, make sure you can afford the monthly payments.
- Make sure the gap you have to pay between the mortgage amount and the cost of the home does not leave you empty-handed in case of an emergency.
- Next, make sure you can afford to sell if you have to. If you sell before the equity builds, you’ll have to put money on the table to offload it.
- And finally, determine how long you plan on staying in the house. The more you pay over the appraisal, the longer you should plan to stay for the equity to catch up.
“The advice that I like to share with my clients is that you are paying the prices for that house that you would have normally paid about 18 to 24 months from now,” says Yawar Charlie,
director of estates division for the Aaron Kirman Group at Compass Real Estate. “Therefore, the calculation is you have to stay in that house approximately two years longer than you normally would have to turn around and regain the equity that you paid at the original purchase price.”
A “home appraisal” is a comprehensive report that determines the value of your property based on a number of factors, ranging from gross living space, to the view and the year a property was built.
If you plan on purchasing a new home with a mortgage or refinancing your current loan (or even getting a reverse mortgage), you will most likely need to order an appraisal. It might also be required for a home equity loan.
Typically, a bank or mortgage broker will handle this for you, but you will still have to foot the bill unless the cost is built into your mortgage rate.
The appraisal is a key component of the home buying process, and important to both you and your lender.
The bank will want to know that the home financing they provide can be supported by the collateral, and you’ll want to make sure you’re not paying more than the home is worth, within reason.
Home Appraisal Costs
- The cost of a home appraisal can vary
- Based on property type, location, and size
- And by bank and mortgage lender
- But most range from $300 to $600
Often when you apply for a mortgage, a deposit is requested by the lender early on to cover the cost of the appraisal. This is how they keep you invested so you don’t go elsewhere during the process.
Home appraisals typically cost anywhere from $250 to $750, with most falling somewhere in between $300 and $600. The cost will vary based on property type, location, and square footage.
Multi-unit properties and properties in rural areas will usually cost more to be appraised than a single-family residence in a densely populated area.
Additionally, a condo appraisal will generally cost the same as a home appraisal, despite the former often being much smaller.
This could be because appraisers must still assess the entire building/complex, which can be time consuming as well.
If the property is a multi-million dollar home, your appraisal could cost over $1,000, and if the loan amount is in the multi-million dollar range, you may also be on the hook for a second appraisal.
How Is My Home Appraised?
- An appraiser will visit your home to determine its condition
- They’ll conduct both an interior and exterior evaluation
- Then compare your property to recent home sales in the area
- Known as “comps” to come up with an appraised value
The most common type of appraisal for a residential property is the Uniform Residential Appraisal Report, or URAR.
It consists of interior and exterior photos, comparison sales (comps), and a complete cost breakdown of the property, such as square footage, lot size, the number of bedrooms and bathrooms, and any home improvements.
This type of appraisal is a blend of both a market and cost approach to determine its fair market value.
The cost approach establishes the value of the home by determining what the cost would be to rebuild the structure from the ground up.
The value approach determines value using comparison sales in the immediate area that have sold within a recent period of time.
When the appraiser arrives at your home, they will take both interior and exterior photos of the property and jot down lots of notes as they move from room to room.
If it’s mortgage refinance, there’s a good chance you’ll meet the appraiser.
The home appraisal process may take an hour or less (some appraisers look around longer than others).
Note: Due to COVID-19, the appraisal process may differ in an effort to minimize or completely eliminate human interaction. This might even require you to take your own photos of the home.
They will also take photos of recently sold, comparable homes in the neighborhood that are being used in the report.
These other properties are comparison sales, or “comps” as their known in industry speak, which are recent sales of like homes.
They are broken down in the appraisal report as well, and compared to the subject property side-by-side.
Each comparison sale is given or deducted value in a number of categories based on how it stacks up against the subject property.
The net value of the comparison sales are then averaged to come up with a median appraised value for the subject property.
Tip: The assessed value of your home is for property tax purposes and could be quite different than your appraised value, which is what the lender uses.
Are Mortgage Appraisals Accurate?
- In general, they tend to be pretty accurate
- For home purchases, they’re often close to the purchase price
- And for refinances they tend to come in at value
- But there will always be exceptions
- And two different appraisers will likely come up with two different values
A recent trend in the industry has been using appraisal management companies (AMCs), which critics claim rely on real estate appraisers that aren’t familiar with the neighborhoods they work in.
This is where arguments start because a lot of times the real estate agent and/or mortgage broker will disagree with the comps used in the appraisal, especially if the property doesn’t appraise at value.
They’ll claim that they should have used X property (a higher valued one) instead of the cheaper ones in the report.
But the independent appraiser licensed to do the job is the one in charge, not the interested party trying to get a sale.
The same type of thing may happen when a borrower is refinancing a mortgage and hoping to get a favorable value.
If it falls short, the homeowner may argue the appraiser’s decision. Of course, it will likely fall on deaf ears.
Ultimately, you will be at the mercy of the appraiser’s valuation analysis, which can certainly range depending on the comps they use.
Whether that’s accurate or not is debatable, but what is likely is that different property appraisers will come up with different values.
It’s doubtful that two appraisers would come up with the exact same price. However, they’ll likely be fairly similar to one another, and ideally not material to the outcome of the loan.
The value of the property is one of the most important factors when it comes to securing financing.
Banks and mortgage lenders need to ensure your property is in good condition, and truly worth what you or your broker say it’s worth because it’s the collateral for the loan.
Any possible valuation inconsistencies will likely cause investors to shy away from purchasing the mortgage, leaving the bank or lender with a vacant property and a major loss if the property declines in value.
Even Donald Trump could agree to buy a shack and fail to obtain a mortgage because the property itself simply isn’t marketable.
This is why they rely upon professional appraisals from an unbiased third party to come up with a fair home valuation.
Do Homes Sell for Their Appraised Value?
- Homes generally appraise at/above the purchase price
- Assuming the agreed upon price is customary and not an outlier
- The key to success is plenty of nearby comparable sales that reinforce the purchase price
- But it’s not uncommon for appraised values and sales prices to diverge
The answer is that it depends. It’s entirely possible for a home to sell at its exact appraised value, but appraisals are typically ordered by the bank (an appraiser selected) after a buyer and seller agree to a certain purchase price.
What generally happens is the appraiser affirms the value found in the purchase contract.
Sometimes they’ll assign a slightly higher value, and other times they won’t be able to find a value to substantiate the sales price.
This can happen if the buyer offered a lot more than asking to beat out other bidders.
It’s not to say they paid too much, it’s just that the other comparable properties sold for significantly less in the professional opinion of the appraiser.
In that case, the buyer and seller may need to go back to the drawing board in order to resolve the valuation inconsistency.
What If the Appraisal Is Lower Than the Purchase Price?
- There are options if the appraisal comes in low
- Ask for an appraisal review
- Put more money down
- Hope the lender will allow a higher LTV
- Or attempt to renegotiate the price with the sellers
One issue that happens pretty frequently is the appraised value coming in lower than the agreed upon purchase price.
This is a common problem because home buyers will often overpay for their dream home, either because of a bidding war or because of an emotional attachment.
Whether it’s truly overpaying is a question for another day.
For example, if you agree to buy a home for $200,000, and apply for a loan with 20% down, you’d need a loan amount of $160,000 and a $40,000 down payment.
That equates to a loan-to-value ratio of 80%, which is simply $160k divided by $200k.
Now imagine the lender comes back and tells you that the property only appraised for $190,000.
Your $160,000 loan amount based on the new $190,000 value would push the LTV to ~84%. And yes, lenders use the lower of the sales price or the current appraised value.
They don’t care what you’re willing to pay for it. They care what an independent appraiser says it’s worth in case they foreclose on you and wind up with it one day.
Anyway, this could be a problem as your loan would now require private mortgage insurance because the LTV would exceed 80%, and that’s if the lender could even offer you a loan above 80% LTV. Often they can’t.
The solution would be to either ask for a review of the appraisal, renegotiate the purchase price (lower) with the seller, look into other loan programs, or put more money down, assuming you have extra cash on hand.
Of course, you might wonder if you’re overpaying for the property if it doesn’t come in “at value.”
Using our same example, if you decided to move forward with the full purchase price and wanted to keep your loan at 80% LTV, you’d only be able to get a $152,000 loan.
That means you’d need to come up with $48,000 for the down payment, as opposed to the original $40,000. The upside is a slightly lower mortgage payment.
You could try to get the seller to lower the sales price too, but that might be a losing endeavor in a hot market.
However, if there’s not a lot of interest in the property, you might be able to get somewhere using this approach.
If you’re selling your home, keep this in mind to avoid dealing with low appraisals, which can lead to buyer fallout and eventual home price reductions.
Appraised Value Higher Than the Purchase Price?
- If the appraisal comes in “high,” which isn’t really a thing
- It doesn’t mean a whole lot other than you may have gotten a good deal
- Or at least didn’t necessarily overpay for the property
- It won’t change the math on your home loan
The opposite could also happen, though it won’t amount to much more than a slight ego boost, and perhaps some additional home equity.
If your appraisal comes in higher than the purchase price, give yourself a pat on the back and breathe out. You’ve cleared one major hurdle in the mortgage process.
However, your lender isn’t going to let you borrow more because of it. Remember, they’ll use the lower of the sales price or appraised value.
So really, nothing changes. You just might feel a little better knowing the property actually appraised.
The terms of your loan should remain the same. This is true of short sales as well. You won’t get extra borrowing capacity just because you’re buying below fair market value.
Be Present When Your Home Is Appraised
- It’s good to be present during an appraisal
- To answer any questions the appraiser may have
- It’s also recommended to clean before they arrive
- And generally put your best foot forward
If you already own your property and are getting it appraised for a refinance, it can be helpful to be there on the day. If it’s a purchase, the current owners likely won’t invite you over.
Anyway, once the lender schedules the appraisal date, make plans to be there to help show the appraiser around the property. You’ll likely need to let them inside.
I also recommend cleaning up the property (curb appeal) to ensure it looks its best, and also being polite and friendly with the appraiser. Real estate agents should extend the same courtesy.
Sure, some may argue that it shouldn’t make a difference if you’ve tidied up around the house, or whether you offer the appraiser a glass of water or a coffee. But for me, it never hurts to be kind.
If you (or the listing agent) are present, you can also point out any recent home improvements that may boost the home’s value, or discuss market trends and similar homes you feel might be overlooked.
Besides, a home that is clean and uncluttered can feel bigger and more expensive than a similar home, and that might be just enough to get a borderline value to where it needs to be.
The same holds true for home inspections, which are separate from the appraisal. It can pay off big to be present when the home inspector arrives.
The Appraisal Review
- If the appraisal comes in low
- Some lenders may order an appraisal review
- To challenge the assessment
- But it’s possible to come in even lower…
Once a home appraisal is ordered, if there are valuation issues the bank or lender may order a review of the appraisal.
The review will be conducted by another appraiser or simply by the use of an AVM, or Automated Valuation Model. This is where many borrowers get into trouble.
If the review comes in low, or if the property is deemed incomplete, hazardous, or unique in any way, a bank may decline the loan and deny financing to the potential borrower.
Even if the borrower has outstanding credit and assets galore, a faulty, unique, or overvalued property can kill the deal.
That’s why it’s always important to use a qualified appraiser who assigns a realistic value to your home so there aren’t any surprises when it’s do-or-die time.
It’s better to know the true value of your home upfront before you sign any contingencies or purchase contracts.
And remember that the quality of your appraisal will determine the quality of your review (unless it’s automated).
The review appraiser will always find the home’s value based on what is given to them.
If they receive a poor appraisal report, they will likely assign a poor value.
I’ve seen brokers submit multiple appraisals and receive completely different values based solely on the original appraisal itself.
As of January 26th, 2015, Fannie Mae let lenders use a proprietary tool called “Collateral Underwriter,” which provides an automated appraisal risk assessment complete with a risk score, risk flags (potential overvaluation), and messages to the submitting lender that warrant further review.
CU works by leveraging an extensive database of property records, market data, and analytical models to analyze appraisals for quality control and risk management purposes.
In the future, lenders may be granted waiver of representations and warranties on value so they can lend more freely, at least when it comes to questionable property values.
[Soon you may be able to buy a house without an appraisal.]
How Long Is an Appraisal Good For?
- Home appraisals have a limited shelf life
- It is dependent on the home loan type
- But most aren’t portable from lender to lender regardless of time
- Meaning if you don’t use the same lender it won’t be valid anyway
Wondering how long an appraisal is good for? It’s a tricky answer because most appraisals aren’t portable, meaning if you get one, you can’t take it to another lender anyway.
So first you have to consider whether you’ll be using your old appraisal with the same lender that ordered it.
If you are, you might be able to use it within a 12-month period, but chances are the lender will need to update it if it’s been longer than four months.
By update, I mean reinspect the exterior of the property and determine if the property value has declined since it was originally appraised. Banks need to ensure they’re not giving you an old, higher value.
A situation where you could use an old appraisal would be if you were thinking about refinancing with a certain bank, then pulled out for one reason or another.
Then a few months later, decided to go through with it again. But as noted, it would need to be with the same lender.
Also consider that the value might be higher, and you wouldn’t get to take advantage of that if you reused your old appraisal.
For Fannie Mae and Freddie Mac, you’re looking at four months, at which point the property would need to be reinspected and the appraisal updated.
For FHA loans, there is a 120-day validity period for appraisals, which can be extended for another 30 days if certain conditions are met.
If an appraisal update is performed before the original appraisal expires, it can be good for as long as 240 days.
For VA loans, the validity period is typically six months and appraisals expire once the loan transaction has closed.
This means you can’t use the same appraisal for a purchase and a subsequent refinance, even if it’s within a six-month period.
For USDA loans, appraisals must be completed within 150 days of loan closing. If they are any older, they might be valid again once updated.
The takeaway is that most of the time you can’t use an old appraisal, so don’t bank on it. Just try to close your loan the first time around.
Although a home appraisal is irreplaceable, you can do some quick research on your own by using a free internet house values tool that generates a quasi-property appraisal in a matter of seconds by simply typing in the home address.
Read more: How accurate is a Zestimate?