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.