Buyers frequently ask, “Am I getting a good deal?” or “How do I know that I am not overpaying for a property?” when having written an offer.
This is a legitimate concern for any buyer and any buyer should make their first step choosing a Realtor that they trust. Once they’ve found a Realtor, is there a sort of, ‘third-person,’ who will ensure that I am getting a good deal?
The answer is yes.
Buyers who are financing the property that they are buying are protected by what is known as a real estate appraisal (a cash buyer may also pay for an appraisal). An appraisal is typically paid for by the borrower and is ordered by the lending institution extending the loan to the buyer.
An appraisal consists of a third-party person (not affiliated with the lender, as per new RESPA Guidelines). They are hired to determine the “Market Value” of the subject property. Lenders/Banks use this as a tool to ensure that they are not over-lending for a specific property.
The result of an appraisal tends to be most important for an FHA or VA loan. Primarily,with FHA or VA loans, banks are lending between 96.5-100% of the value of the property. 5% down conventional loans would also rely heavily on the appraisal report. As a result of the bank lending so much money in comparison to the value of the property, the lender’s pencils are known to be very sharp when it comes to reviewing an appraisal report and the qualifications of a buyer. The appraisal report can absolutely make or break a deal.
If the appraisal comes in low, or below the offerring price, the bank may choose not to lend on the property. As most buyers are encouraged to include an appraisal contingency in their offer to purchase, buyers may – at this point – walk away from a deal without losing any of their deposit as a result of a low appraisal. Don’t consider your deal dead-in-the-water just yet though. Work closely with the Realtor and find out what options the lender has to make the deal happen. Everyone wants to see a deal happen.
Also, there is more leniency on the side of the lender if the borrow is putting down a large downpayment such as 20-30% down. (Click her for advice on how to ensure that an appraisal does not come in low.) For instance, if your offerring price is $400,000 and you are putting down 20% of the purchase price, even if an appraisal comes in slightly below ($10-15,000), the lender may still move forward with the loan (no guarantees though).
What does an appraiser usually do?
- Takes photographs of the property (inside and out)
- Compiles notes and sketches while physically inspecting the property
- Reviews the market history of the subject property
- Searches for comparable listings (known as comparables) of Active, Pending, and Sold listings within a recent time frame in the market. Comparable listings typically include properties within the same tract, but may also include properties of similar size and location as comparables. This is known as the Principle of Substitution. For example, if a buyer can purchase a 4 bedroom 3 bathroom property actively on the market in a certain tract for $300,000, why would someone pay $400,000 for a 4 bedroom 3 bathroom property that is also actively on the market in a similar tract and in similar condition? (This is where direct comparisons would add or subject value from the properties being reviewed).
- Review the “Sold Price” for comparable listings while also considering the days on the market for those listings.
- Review the price per square foot for each comparable unit and calculate means and medians between the subject property and the comparable properties
- Add or subject value from or to the subject property based on its condition and upgrades or lack thereof.
- Compile a report explaining the appraiser’s decision of the property’s value.
So, did the buyer get a good deal?
Here’s the thing. At this point in the real estate cycle (the bottom), real estate appraisers are extremely critical of properties. What this means is that they tend to bring in appraisals low. This is a result of banks having sustained such large amounts of loss that these banks turn to the appraisers and say:
“You better protect me, I don’t want to lend more than this property is worth,in case things go bad!”
These low appraisals have been known to bomb deals – and that is why it is crucial to follow these steps to prevent a low appraisal: (Click her for advice on how to ensure that an appraisal does not come in low.)
In this low point in the real estate cycle, if your appraisal comes in to a point where the lender says they will lend on the property, you can be fairly sure that you are not overpaying for the property, because the bank won’t let you.
So is now a good time to buy? Checkout this blog-response and make sure to read the arguments in the comments section to: Is Now a Good Time to Buy?