What happens when an appraisal comes in under contract price...?

A lower appraisal doesn't have to mean your deal is finished - especially if you plan ahead and let buyer and seller know their options.

With home prices rising, appraisals are an important consideration for everyone in your transaction. In earlier newsletters, we discussed the inputs, methods, and standards of residential appraisals.

Today's discussion is not about those appraisal specifics. It is more about appraisals' influence and effect on purchase deals, and to help buyers, sellers, and Realtors� be more comfortable with them..

When you take a new listing, you have no way of knowing whether the buyer will bring cash or use financing.

Therefore, you may want to discuss with sellers the importance of their property appraising for somewhere near the eventual contract price they have in mind.

All financing requires an independent appraisal

of the home's current market value.

This can lead to a discussion of where similar properties' selling prices ended up in relation to their original listing prices and DOM. The possible results of an appraisal can sometimes help add a level of reality when speaking with sellers about asking prices.

Under the Comparable Sales appraisal method, a subject property cannot appraise higher than the highest valid comp.

It can appraise higher than contract price, though not higher than the highest usable comp.

An appraisal is a third-party opinion of value that helps lenders more closely determine the Loan-To-Value (LTV) ratio, one of the more important measures in all lenders' risk management.

Purchase price - Down Payment = Loan Amount

Loan Amount / Property Value = LTV %

The property value used by lenders to calculate LTV

is the lower of contract price or appraised value.

In most cases, the appraisal will support the contract price. However when an appraisal comes in lower, the lender's LTV calculation uses the lower appraisal number, which means they will be lending a percentage of that lower value rather than a percentage of the higher contract price.

Here's a basic example :

	Property Value	LTV Ratio	Maximum Loan Amount	Down Payment
Contract	$400,000	90%	$360,000	$40,000
Appraisal	$396,000	90%	$356,400	$39,600

In this example, the buyer/borrower would have to pay more

upfront in order to continue with the deal and still comply with the original contract price.

The lender will only lend 90% of $396,000 - not 90% of $400,000, so the buyer has to come up with the difference to make the deal work.

That's the $39,600 down payment (10% of appraised value) PLUS the full $4,000 difference between appraised value and contract price.

At this stage, buyers have a few choices:

- Put more cash into the deal (if they have it), paying the

difference between the lower appraised value and the

higher contract price.

Note: It's OK to pay a little bit more than appraised price for

the right home. It can indicate a healthy local market with

realistic price appreciation taking place. Comp values can

lag current sales in this case.

- If the additional money is not available, exercise the

Financing Contingency (if there's still time) to terminate the

contract since the maximum allowed loan amount is lower

than needed.

- Buyer and seller negotiate further. Rather than lose the deal

completely, a seller may be willing to modify the contract

price or offer contributions to closing costs which can

offset the difference.

An appraisal that comes in low can also be questioned. The completed 1004 Appraisal Report includes the comps the appraiser used and his/her reasoning behind the adjustments to value.

When considering an appraisal dispute, everyone also has to remember that they take some extra time, and the contract clock is still ticking. They often require a closing extension, so we should have a pretty good case before starting a dispute.

From a buyer's perspective, I like Appraisal Contingencies, which are used with Financing Contingencies and allow more options to get the deal closed if an appraisal comes in low. They usually open the door for continued negotiations rather than terminating the contract the way a stand-alone Financing Contingency can.

Appraisals are often misunderstood and feared.

They start affecting a transaction right from the listing appointment, and continue through the time a completed
appraisal report comes back to the lender.

Yet as we have discussed today, they don't have to sink your deal. I feel it's important for both buyer and seller to understand what goes into an appraisal and what their options are if it comes in lighter than contract price.

Whether it's about appraisals or anything else related to their purchase,have your buyers call me early in the looking stages so I can give them the details they need to make an informed financing decision.

Let me reinforce the trust

your buyer has placed in you! sm