It might surprise some to know that the sales contract isn’t the final value of the home, at least in the lender’s eyes. When negotiating the price of a home market forces shape a price based upon the most the buyers are willing to pay with the least amount the sellers will accept. This assuming there are no external influences that may affect the seller’s list price.
An external influence might be someone forced to relocate quickly and needs to sell before being able to buy and finance a subsequent property. Or maybe the home is getting close to being foreclosed upon and the owners need to sell the home fast and pay off the outstanding mortgage balance. Outside of these external factors, it’s assumed the final sales price reflected current market conditions.
Most often the appraisal reflects the sales price. When an appraisal is ordered, the appraiser receives a copy of the sales contract showing the amount the buyers and sellers agree to. Before the appraiser steps one foot outside there is some initial research completed. The appraiser looks at recent home sales in the area that are similar to the subject property.
In most states, this information is readily available via entries in the public record. Some states however keep this information private. If someone has access to the Multiple Listing Service, this information is easily available. Either way, the appraiser does some initial homework before inspecting the property.
It’s important to note there the appraiser’s job is to establish value and is not the same individual who will physically inspect the property for any seen and unseen defects that need some attention. The appraiser’s job is to establish value based upon recent sales of homes in the area. If the sales contract says the agreed to price is $250,000 then the appraiser will research other homes in the area and compare them all. Sometimes the appraised value comes in higher than the sales price.
But what some think is this extra value is immediately available to the buyers in the form of equity or even help out with the down payment. Neither applies. If the appraised value comes in higher, well, that’s great for the buyers. It’s when the appraisal comes in lower that can cause some problems.
The lender will always use the lower of the sales price or appraised value when evaluating a loan application. If the sales price is $250,000 and the appraisal $260,000, the lender still uses $250,000 as the value. If the price is $250,000 and the appraisal $240,000, the lender will use $240,000. This leaves the sellers with a dilemma. Either come in with the extra $10,000 or walk away from the transaction entirely.
There might be another option which is to order another appraisal, but the new appraiser will be using the very same information the first one did. Or, the sellers will agree to a new, lower sales price. Most often this is the result because the sellers know they’ll more than likely face the same issue with the next offer and understand their property might just be overpriced for the area.