You may go through an appraisal if you’re buying a home with a mortgage or refinancing your current mortgage. An appraisal can also be a key part of the transaction if you’re selling to anyone aside from an all-cash buyer. Understanding how appraisals work is important whether you’re a buyer, seller, or owner.
The appraisal is an unbiased opinion of the value of your home from a professional. It’s used any time a mortgage is involved with the property.
Qualified appraisers create reports based on an in-person inspection they do. They also use recent sales of similar properties, aspects of the home like floor plans and amenities, and current trends in the market.
These appraisals are a way to make sure the contract price for a home is appropriate, given the factors above. A lender doesn’t want anyone overborrowing because the home is the collateral for the mortgage.
If a borrower defaults on the mortgage and then goes into foreclosure, the lender sells the home to get back the money it lent. An appraisal is a form of protection for the bank because it doesn’t want to lend more than is recoverable if a worst-case scenario happens.
A borrower will usually pay the appraisal fee, and it’s important because if the appraised value comes in lower than expected, it can delay the transaction or even lead to a cancelation.
The following is a guide to how the comps affect an appraisal.
What Are Comps?
While the home itself is key in the appraisal, so are the comps.
Real estate comps are the homes recently sold that are like the property the appraiser is assessing. The similarities might include location, condition, size, and features. The goal is to use these comps as part of a larger puzzle to determine the fair market value of a home.
The sales comparison approach uses the substitution principle to determine the value of a specific home.
This principle indicates you can determine a home’s value by finding out what it would cost to buy a similar and theoretically equally desirable property.
The more equivalent comps to a property being appraised, the more accurate the pricing.
The properties' location, condition, and square footage should be as close to identical as possible. Other elements of a home are also taken into consideration, like the lot size, special features like garages and pools, and the age.
For true similarity, the comps should have sold in the last 3-6 months under conditions that are as close to the state of the current market as an appraiser can get.
An appraiser can determine how your property differs and calculate how the differences might affect the sales price.
For appraisals specifically, they’re only supposed to look at sales that happened within the last 90 days. If there aren’t enough sales, they could go back 6-12 months, even though the ideal is 90 days.
How Do Appraisers Gather Information?
Appraisers will look at the MLS to get a lot of their information for comps. Around 90% of appraisers use the MLS as their reported primary source of gathering data, but they still have to cross-check the information they find there. They have to compare largely against public records.
If there’s a lack of comps or in states with no MLS or disclosure, the appraisal still must be done accurately.
When there aren’t good comps, an appraiser may use an income or cost approach.
In the cost approach, the appraiser determines what you’d pay for the house's land based on what land sells for in the local area. Then the appraiser would figure out what you’d pay to build the property that’s on it.
Appraisers are trying to make a case for value, so they have to be specific in the way they go about weighing a comp.
With the income approach, the appraiser will estimate the value of a property based on the income it generates. The appraiser uses the net operating income of the rent collected and then divides it by the capitalization rate.
According to Fannie Mae, an appraiser must use at least three closed sales, and the subject property can actually be a fourth comp if it sold recently.
The appraiser might use a one-mile radius for comps if a home is in a suburban area, but that’s not a hard and fast Fannie Mae rule.
Finally, some appraisers might stay within a few streets to determine the best comps, while in other cases, they might have to go a few miles away to get the right comps.