People often confuse the home appraisal with a home inspection. In fact, they serve different purposes and each one is an important part of the home-buying experience.
An appraisal is a property valuation and its primary purpose is to protect the lender. Before approving a home loan, banks, mortgage companies, and the FHA (Federal Housing Administration) will require an appraisal to determine the maximum amount they can lend within their underwriting criteria.
When an FHA mortgage is involved, the appraiser is required to disclose all potential safety issues to the buyer. Conventional mortgages don’t require the same level of detail in the appraisal regarding the safety, security and soundness of the home. What the lender is looking for in the home appraisal is the fair market value of the home. The appraiser initially conducts a fairly quick on-site visit to confirm such things as square footage, number of bedrooms and bathrooms, and overall condition. Then the appraiser looks at comparable sales, or “comps”, in the neighborhood. Appraisers have access to the Multiple Listing Service (MLS), which is a database of all the homes in a given area that are listed for sale or have recently sold. The appraiser will research homes that have been recently sold in the area that are similar in size, condition, and location. The appraiser will provide a final report to the lender based on the information from the on-site visit and data from the comps.
So what happens if the appraisal comes in lower than what the buyer and seller have agreed on as a purchase price? Believe it or not, there are actually a lot of options. Option 1: The seller can reduce the price to match the appraisal value. Option 2: The buyer can put down more money to cover the difference. Option 3: The seller and buyer can negotiate a new price somewhere between original price and appraisal value and the buyer can make up the smaller difference. Option 4: If the appraisal value is completely ridiculous, the buyer can obtain another appraisal by obtaining financing from a different lender (we run into these issues with larger national lending institutions). Option 5: If it’s a FHA or a VA loan and a question of major repairs, the seller can fund a separate escrow account to cover the cost. Option 6: The buyer can walk away from the transaction.
The importance of the home inspection
The home inspection is not relevant to the lender but provides detailed, invaluable information to the buyer.
A certified home inspector will usually spend several hours thoroughly going over every part of the home, from roof to basement, examining shingles, windows, siding, electrical, plumbing, HVAC, foundations, water heaters, land grading, and much more. The inspector works for the buyer and is obligated to provide feedback on the condition of the home in a way that educates and protects the buyer from otherwise unforeseen problems. Once the inspection is completed, the home inspector will provide a written report suggesting any improvements or repairs necessary to bring the home up to current standards. Home inspections can sometimes reveal problems that could be expensive to fix. The report can be used as a powerful tool to get the seller to pay for repairs prior to closing or to negotiate a lower selling price.
Note that licensed appraisers and certified home inspectors are professionals who you can expect to do their job impartially. They are both compensated by the purchaser whether the home sells or not.