Low Property Appraisals – The Hottest Topic in Real Estate?

There is much ado about low property appraisals lately. Many home builders, sellers and real estate agents complain that appraisals are skewed by foreclosure homes.

Low property appraisals are the topic du jour in the real estate world. Today, for example, nearly a dozen major news outlets ran stories about low appraisals on their real-estate front pages. It’s also generating a lot of discussion, such as this recent Q&A session on the MarketWatch website.

We are going to throw our hat into this ring as well, but from a different angle. In true DHN fashion, we will put this news into perspective for first-time home buyers. Here’s what a first-time buyer should know about property appraisals, and what it means when they “come in low.”

What is a Property Appraisal?

When you buy a home, the mortgage lender will send a professional appraiser out to review the property. He or she will compare the house you’re buying to recent sales in the area. They also consider upgrades to the property, such as swimming pools and kitchen renovations. Based on all of this, the appraiser will come up with a property appraisal — an educated guess of the home’s current value. The lender does this to protect its own financial interests. If the appraisal comes in lower than the amount you’ve agreed to pay, there’s a problem.

When the Appraisal is Below the Purchase Price

Let’s say you’re interested in a home that’s listed for $270,000. Your real estate agent reviews some comparable sales in the area and advises you to offer $250,000. You do this, and the sellers accept your offer. If you’re paying cash, the deal is nearly done. But if you’re using a mortgage lender, like most people, you have to get their take on the home’s value. So the lender sends an appraiser out to evaluate the home, and he says it’s only worth $210,000. Based on the low appraisal, the lender is only willing to give you a loan for the lower amount — $210,000.

This kind of scenario happens often, especially in the current economy. High foreclosure rates have a lot to do with it. Many real estate agents don’t use foreclosure sales when they evaluate pricing. But a lot of home appraisers do consider foreclosures. Thus, we have a discrepancy in values. In the current real estate market, this a common reason for low property appraisals.

How it Affects Home Buyers

A low appraisal actually works in favor of the home buyer. In the end, it can help you save money on your purchase. It can also prevent you from paying more for a home than it’s worth. The down side is that it can add some hiccups to the process.

For example, if your initial offer gets accepted, a low property appraisal could delay (or even derail) the whole transaction. It all comes down to what the sellers do in response to the lower appraisal. If they agree to lower the asking price to reflect the appraisal, then the deal is back on. If they stick to their original / higher asking price, then you’ve got a problem.

Here’s the bottom line. It’s never a good idea to pay more for a home than it’s worth. This puts you in a negative-equity situation, right from the start. But it’s not always easy to determine the “true” value of a home, especially when different players are looking at different data. If you’re presented with two different appraisals from two real estate professionals, you should base your offer on the lower of the two.

Home Prices in Your Area are the Only Ones that Matter

If you only read the news headlines right now, you’d think every real estate market in the country was experiencing an upswing. For example: “Home Prices Rise for the Fifth Month in a Row.” That’s the headline making the rounds today. But this is based on national trends and averages, so it’s essentially useless to an individual home buyer.

home prices seesawTake Denver and Las Vegas, for example. From a home-value standpoint, these two cities are on opposite ends of the seesaw. Prices in Denver have been rising pretty steadily for the last few months. On the contrary, home prices in the Las Vegas metro area continue to fall, with no “bottom” in site.

So a headline proclaiming a rise in home values would be irrelevant to a buyer in Las Vegas (or one of the many other declining markets in the United States).

As a first-time home buyer, there is only one real estate market you need to worry about, and that’s the market where you plan to buy. Here are some of the key factors you need to know about home prices and other factors, before you buy a house in a particular area.

5 Things to Know About Your Real Estate Market

  1. Home-value trends for the last 12 – 18 months. This will give you a general sense of what has happened in your area (bubble or no bubble), and will also help you understand the other items below.
  2. Changes to home prices in recent months. This gives you a more accurate idea of what’s happening in your real estate market right now. Combine this with item #1 above, and you’ll know whether a home purchase is a good or bad investment right now. If you buy a house in a declining market, you could be losing equity from day one.
  3. Price differentiation for the neighborhoods / areas you are considering. In some areas, prices are fairly consistent across the board. But in other cities (like San Francisco), you can pay 25% more for the same house just by going across the street. You need to know how neighborhoods affect pricing in your area, in order to make an educated decision.
  4. Foreclosure rates in your area. Do you live in a high-foreclosure area? If so, home prices are less likely to rise (due to the increased surplus). Also, if you’re up for the challenge of buying a foreclosure home, you could save money by purchasing below market value. The first step, as always, is to understand what’s happening in your local real estate market.
  5. Property taxes in different neighborhoods and communities. I live in Round Rock, Texas, which was recently named the second-fastest growing city in the U.S. Property taxes here are ridiculously high. But if I had purchased a home in the subdivision across the street (a Municipal Utility District), my taxes would have been much higher. Taxes are the ‘T’ in the PITI acronym that makes up your mortgage payments — principal, interest, taxes and insurance. So a higher tax rate means a larger mortgage payment each month. You need to research this for your area.

National real estate trends help us understand what’s happening in the country as a whole. And that’s all well and good — there’s certainly a need for that kind of information. But for an individual home buyer, they are not nearly as important as local real estate trends in the desired area.

Reminder: Housing Tax Credit Expires in April 2010

If you are thinking about buying a home in 2010, you might want to do it before the end of April. That way, you can qualify for a tax credit of up to $8,000 (if you meet the other requirements).

The federal housing tax credit gives first-time home buyers some added incentive to buy a home. Granted, you should never purchase a home until you’re financially ready to do so. But it certainly helps to get a tax credit of up $8,000. The program has been extended until April 30, 2010, and it could even be extended beyond that cutoff. As of right now, however, you must buy a home by April 30 to qualify for the credit.

Here are some notable dates, straight from the horse’s mouth (the horse being the IRS):

“You must buy the home after April 8, 2008, and before May 1, 2010 (with closing to take place before July 1).” –Source

Housing Tax Credit Q&A

Here are some frequently asked questions about the program:

1. Who can claim the $8,000 housing tax credit?

Anyone that meets the loose definition of “first-time home buyer” is eligible for the federal tax-credit program. I put it in quotes because it has a broad definition. If you have not owned a home (as your primary residence) in the three years prior to your home purchase, then you meet the IRS definition of “first-time” buyer.

Example: Let’s say that I buy a house in February, and my closing date is on March 3, 2010. If I have not owned a home as my principal residence between March 3, 2007 and my 2010 closing date, then I’m eligible for the $8,000 housing tax-credit program. Of course, I might not qualify for the maximum $8,000 amount — that would depend on the purchase price of the home I bought. But I would qualify for a credit of some kind. Remember, you must purchase by the end of April, but your closing date can later than that (before July 1, 2010).

2. Are there any other restrictions, such as income?

Yes. Rich people are excluded from the tax-credit program. But seriously, there are some specific income limits for the program. Single filers must make less than $125,000 per year, and joint filers must make less than $225,000. Please note the publication date of this article (December 2009). This program could very well change in the future, so you’ll need to visit the IRS website for current details.

3. Is there anything for homeowners buying a new home?

Yes! Under the expanded tax-credit program, homeowners who sell their current home and then buy another one qualify for a credit as well. In this case, the credit amount is up $6,500. The same deadline applies.

4. Where can I learn more about the credit?

I recommend visiting the IRS website. There’s a lot of misinformation floating around about this program, especially on the Internet. I have seen some frightfully inaccurate information posted on blogs and websites. So start with this IRS explanation of the federal housing tax credit, and you’ll know exactly how it works.