Regardless of what your sales contract says when you buy that higher-end home in California, that might not be the final value your lender will use when evaluating your loan application. Does that surprise you? It does many, but the value lenders use is what is reported in the appraisal report.
The appraiser takes a copy of the sales contract for review, but it’s just a starting point. Here’s a rundown of what appraisers do when coming up with a final appraised value for your home, for purchase as well as when refinancing.
Pretty much every mortgage today requires some type of appraisal, whether it’s a conforming, jumbo, or government loan. A conforming loan is one where the loan amount is at or below $726,200 for most locations across the U.S. The limit is increased to $1,089,300 for high-cost locations, many of which reside in California.
Any loan amount that exceeds this is considered a jumbo loan. Jumbo loans will be processed in much the same manner as conventional loans with a few exceptions. Interest rates for jumbo loans will be slightly higher than those reserved for conforming loan amounts due to the incurred higher risk.
Let’s say that you found the home of your dreams and the sellers are asking for $950,000. Your realtor does some research and decides the sellers will accept something closer to $925,000 based on recent sales in the area. So you decide together to make the offer of $925,000 and the seller accepts. With both your and the seller’s signature on the sales contract, you forward a copy to your loan officer.
The application and the sales contract are being processed and your loan officer orders an appraisal through an appraisal management company or “AMC” This company will then randomly select an appraiser from an approved list. The order is placed, and the appraiser begins to work.
One of the very first things the appraiser does is do some research on the area where your selected home is located. Public records will show which homes sold, for how much and when. Only properties that are similar to yours will be used for comparison. For instance, if there are any luxury condos in the area and you’re buying a single-family home, the condos can’t be used for the report.
How many recent sales will be included in the report? Jumbo loan guidelines can vary by program but in general, the appraisal must include at least three sales within the previous 12 months, with at least one of those within the last six months. Some programs require four sales instead of three. The appraiser will also report a property that is currently listed for sale but not yet under contract. These homes are referred to by lenders as “comparable sales” or simply “comps.”
This is the initial research. The appraiser will then calculate a price per square foot amount and compare those numbers with your property under contract. If your property is 5,000 square feet and sold for $925,000 that works out to $185 per square foot. This amount will then be compared to the other properties. The next step is to make some adjustments based on various characteristics of the properties because single-family homes are rarely exactly alike.
Looking at one of the more recent sales, the home sold for $975,000, or $50,000 more than your property. But the other home has a swimming pool and yours does not. The appraiser will add additional value to an amenity such as a pool, spa, outdoor deck, or entertainment area. The property also has a sprinkler system to keep the lawn and landscaping healthy and green. On the appraisal report, the appraiser will make adjustments based on different features that appear or do not appear.
Maybe your selected property has an upgraded kitchen with brand new appliances and granite countertops. A newer kitchen will add value to a home. What other features can add value? A fireplace will add value. A 3-car garage vs. a 2-car garage will. Hardwood flooring, a screened patio, or a porch increases the value. Location can also play a part. If the home backs up to a greenbelt that adds value. Being on a quiet street or a cul-de-sac is sometimes a cause for an adjustment. A nice view will always help.
Higher or Lower?
Most of the time the appraised value matches the sales contract price. After all, in an open market, the buyers and sellers have agreed to a market price. But sometimes it’s different. What happens if the appraisal comes in at $950,000 and your contract says $925,000? First, it says apparently you got a pretty good deal.
But what won’t happen is your ability to use that additional equity as part of your down payment. The loan purposes, the lender uses the lower of the appraised value or sales price. The appraisal might say $950,000 but your down payment will still be based upon the $925,000. If your down payment is 20%, that means 20% of $925,000, or $185,000.
If the appraisal comes in lower than $925,000, then there’s another issue. Because lenders establish a loan amount based upon the lower of the sales price or appraised value, if the appraisal comes in at $900,000, you’ll have to come in with the difference of $25,000 before you even get out of the starting gate in addition to your 20% down payment. Most sales contracts have wording that allows you to withdraw your offer should the appraisal come in lower than the sales price.
Lenders can also ask for two separate appraisals instead of just one. This is especially true when the sales price exceeds $1 million and depending upon the loan program. When two jumbo appraisals are required, the lender will use the lower of the two when evaluating the loan application.
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