Understanding your home appraisal

This is a guest post from Liz Freeman, who writes about mortgage and finance issues. Freeman is the spokesperson for ShopRate.com, an online tool for finding the lowest mortgage rates since 2000.

“If I'm willing to pay X for the home, it must be worth X, right?” There's a lot of truth to that statement. Most accountants will tell you that the proper value of anything is either the lower of what it cost to acquire it, or what someone is willing to pay for it.

But a lender has to look at things differently. You may think that adorable hot pink house next to the off ramp, the strip club, and the convenience store is perfection and a steal at the price, but your lender wants to be sure that the property (AKA, the collateral) could be sold for enough to repay the loan if you default.

There Goes the Neighborhood — and Your Home Value

Lenders learned the hard way that they don't just have to worry about the present. They have to consider the future when deciding how much to lend against a property. And what's happening to homes in your neighborhood affects your value — if sales prices are down, your value drops too — even if your home is the gem of the street and perfect in every way.

Today's appraiser has to fill out a “market conditions addendum” in addition to the regular appraisal. It includes an exhaustive analysis of housing values and trends where the property is. If your neighbors (yes, the ones with the 50-foot boat, the motor home, and big screen TVs in every room) blow off their mortgages and the street is littered with foreclosure sale signs, you are out of luck. Your neighborhood will be tagged with the label “declining.” Not only does this create problems for you, the seller, but it also makes things difficult for a potential buyer. The best mortgage rates out there may not be available, and a higher-than-usual down payment may be required.

Okay, But What About Your Home?

The appraiser looks for recently sold homes that are comparable to yours — with similar square-footage, grade of construction, views, and features. These are referred to as “comps.”

The appraiser takes pictures of the comps as well as of your home. Then, he or she calculates your home's value and creates that complicated report. Several things might alter your value — for example, you live in a tract and everyone pretty much has the same floor plan. But your property overlooks a golf course (free landscaping, yay!) while your neighbor across the street has a view of that hot pink house, the strip club, and the convenience store. You get a higher value because your view makes your home worth more.

Improvements Are Nice…

Certain home improvements deliver more bang for your buck. Renovating an outdated kitchen, adding a bathroom when one isn't enough, or re-doing old siding can increase your appraised value and pay big dividends when selling or borrowing against your home.

…But Don't Overdo It

Turning your home into the envy of the neighborhood — a park-like garden, meditation pool, imported stonework, and commercial appliances may add value if you live in mansion territory. If you reside in a working-class area and go nuts with the additions, you won't get extra credit. Appraisers refer to this as “over-improving for the area,” and your extravagance will not be rewarded.

So, What's it Worth?

Your home will be valued two ways. The first calculation, found in the upper left-hand corner of page two, is its estimated cost including the value of the lot, the improvements to the property, and minus any depreciation. However, while this might be important when insuring your home, it's the number at the bottom of the page that matters to a lender — the market value of the home, which is a better indicator of what could be recovered if you default on your mortgage.

Can the Appraiser Be Wrong?

You bet! Appraisers, like those in all professions, range from the highly trained and motivated to the sloppy and ignorant. And what you get depends largely on luck. Today's Home Valuation Code of Conduct (HVCC) requires that appraisers are engaged by appraisal management companies that have no relationship to anyone who stands to gain financially from the transaction. While this can protect homeowners and lenders from unscrupulous valuation, it also means the appraiser has no incentive to do a good job. And sometimes an appraiser located hundreds of miles away will be asked to appraise your home and that could easily cause your property to be valued incorrectly.

If you feel that your home received unfair treatment, request a second appraisal (but be prepared to pay for it). You may want to try another lender — a different appraisal management company may well turn in a higher value. And if the house is hot pink, consider repainting.

Photo by John the Scone.

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Chad
Chad

I agree, Liz. We’ve had our share of poor appraisers. Our current house was appraised by rounding the asking price to nearest thousand.

Wes
Wes

It was explained to me when we bought in April that the apraisal would come in at the list price. Period. After rampant abuses in the home appraisal/ sales industry, I was told, now you are going to get the appraisal at the list price in order to prevent the appearance of impropriety. Take our appraisal for reference- two homes within a half mile, recently sold with similar construction and condition appraised at approximately $170 per sq. ft. which would have put our appraisal at around 125% of list price. House number three was a complete dump with a different… Read more »

Tyler@Frugally Green

I think the mention of the appraiser being required to be completely separated from the borrower and lender is a fairly recent development, no?

I have a friend who’s a mortgage broker and was explaining the other day that new legislation was passed to prevent one side or the other from influencing the valuation of a property and that, while well intentioned, is currently wreaking some havoc on the industry as lenders try to find competent appraisers now that they can no longer use their in house appraisers.

Todd @ Personal Finance Playbook
Todd @ Personal Finance Playbook

I would think that appraisers would be doing pretty well right now, with all the re-financing that’s gone on in this market. When the markets booming, they have plenty of work. When the markets slow, they lower interest rates and people re-finance. I don’t know anything about it as a profession, but that’s my perception. Any appraisers out there want to educate me?

RB @ Financial Samurai
RB @ Financial Samurai

One thing worth noting is that your appraiser is in CAHOOTS with the bank at any given point in time. If the appraiser doesn’t appraise at the right level, the bank can’t make the loan, and the bank will think twice about hiring the appraiser again. It’s worth taking the appraiser’s advice if his/her number comes in below what you bid. You should use that as leverage to renegotiate with the seller, and if not just walk away. Just keep your eyes WIDE OPEN during the house buying process. Every step of the way danger lurks. Ask questions constantly. Best,… Read more »

clockworktomato
clockworktomato

Completely off topic, JD, but be sure to wish your MINI happy 50th birthday today! 🙂

If you pop onto the MINI.com Owner’s Lounge you can get a free copy of their magazine in commemoration of the 50th birthday.

Liz Freeman
Liz Freeman

I think ‘cahoots’ is a bit strong. Every lender that I ever dealt with had a blacklist of appraisers they would not accept appraisals from because they consistently OVER valued property (perhaps to please a Realtor or refinanciing homeowner). Many also have appraisal reviewers or committees. It does a lender little good to make a big loan on insubstantial collateral. Re: the appraisal coming in at the sales price despite the home being worth more, I’m the US that would not affect your required down payment or the need for MI. The acquisition cost is considered the value for lending… Read more »

mbrogz3000
mbrogz3000

I was able to buy a new home in the expensive NJ housing market about a year ago with 10% down, and without any PMI. A bank appraisal was done, but I don’t think anyone ever set foot on the property to do it. I was able to get the gears involved with mortgages moving and complete literally 2-3 weeks before the ‘new rules’ went through. The bank appraisal was for 5% more than what we paid for the house (in a nice quiet neighborhood of hardworking people), but again, I still question if the appraisal in my case was… Read more »

MichaelM
MichaelM

Making improvements to the home to increase its value is confusing to me. It seems like any improvement will cost more than the amount the value of the house will increase. For example, $5000 of new windows will not necessarily increase the value of your home by $5000, right?

Our game plan is to make improvements to our home that will let us enjoy it more. When it comes time to sell (in 3 or more years) we’ll hope that the buyers also like the improvements we’ve made.

Susan
Susan

As an accountant, no accountant will tell you that the proper value of something really is the lower of cost or market. The lower of cost or market is the most conservative way to record the value of an asset for financial statement purposes. What that means is that we can confirm the cost because we know what you paid for it. We can’t be absolutely sure of the market value of something until it’s actually sold. Therefore, we use the cost unless there’s some reason to believe that the cost is an inflated measure of value, in which case… Read more »

Liz Freeman
Liz Freeman

I worked for Deloitte in an earlier life and one of my degrees is in accounting. Per Generally Accepted Accounting Principles (GAAP), that is the way to value –conservatively. If you prefer common sense, most people would say that the value of an object is what someone is willing to pay for it. And while you can’t say what the market value is for sure until something is sold, the appraisal is as close as you can get for that purpose. It takes the homes that actually WERE sold and compares them to the subject property, quantifying any differences between… Read more »

David
David

But the houses that were sold previously and used as a current comp were maxed out in value by using the houses that were sold before them as comps. How is an area homes ever to be worth more if they are all held to the homes that were sold before them and before them and before them. Unless people are paying cash for the difference and who really does that that often how does that market value increase?

David@DINKS Finance

Hell yeah appraisers can be wrong. Unfortunatley for them they have to gauge what people THINK a house is worth. After the housing crash, obviously appraisals went down. But if three years ago you told someone “this house is only worth $200,000, not $350,000, but you might be able to sell it for the higher price now, but it is not worth that much” they would probably think the appraiser was a little looney.

Matt
Matt

My home appraisal for the home I bought last month came in (coincidentally, of course) at exactly the price I paid for it. We’re renovating our kitchen now (it was ugly, old, and oddly configured), and are trying to make some other (low-cost) improvements over the next year or two. It of course depends a lot on the market, but hopefully over the next 2-3 years the combination of making biweekly payments and the increased value from changes we make will allow us to stop paying the mortgage insurance that came with the FHA loan (which happens once the amount… Read more »

KC
KC

I’d always heard you want to be the least expensive home on the street. I never quite knew what that meant until I went to buy a home. Our first home was 2 bdr/2.5 baths and was one of the least expensive on the street. We picked it cause it was a really nice street and we wanted to live there, but we couldn’t afford any of the other homes. When it came time to sell…we had no problem, such a beautiful street – that inexpensive home moved fast. Now we bought a 5 bdr/4 bath house and it is,… Read more »

RJ Weiss
RJ Weiss

Interesting article. Learned a little, even though I just went through the home buying process in April.

Also, looking to stop paying PMI because we only put down 10%. Liz or anyone else, besides the upgrades you listed in the post, what other upgrades have the most impact to appraisers? Our siding, kitchen, and bathrooms are already up to date, is there anything else we should concentrate on?

J.D.
J.D.

@IckesTheSane Not bad etiquette to link to a forum post. Not bad etiquette at all! I keep looking for ways to feature the forum more prominently, and the comments seems like a great place to do so. @Everyone Kris and I bought an old house in 2004. We’ve done a lot of work on it. For a while, I fretted over how each project affected the resale value, how much return we’d get on the money we spent. Ultimately, I had to stop looking at things like that. Yes, return on investment is one factor, but it’s not the only… Read more »

Kevin M
Kevin M

I’m sure there are some good ones out there, but do you really think a bank will let a deal fall through for a couple hundred dollar appraisal fee? If it doesn’t appraise, they’ll find another guy to do it. Appraisers know this, and know the selling price, so it seems convenient that the appraised value usually comes in a couple thousand above the selling price. (I’ve sold 3 homes, I know how the game is played. The last one I sold was a month ago and the appraiser was there all of 5 minutes to review our home.)

mjukr
mjukr

I don’t think any of this really matters if you think the amount you’re paying for the house is reasonable, and it’s in the ballpark of nearby comps (within 3% perhaps). Honestly, if you find a house you really like, in an area you really like, and you plan to stay there for many years, do you really want to back out because you *might* be paying a few thousand more than its “value”? People will tell you “oh I’d keep looking”, but anyone who has actually been through the process knows that there are very high opportunity costs (not… Read more »

Liz Freeman
Liz Freeman

It depends so much on where you live and what is expected in your neighborhood. A gee-whiz kitchen won’t help if you have the only one bedroom house on the street. Pools can drop your value in most areas but are de rigueur in Las Vegas or Phoenix. Most experts say that taking care of any deferred maintenance should be top priority. Builders or Realtors in your area can help with what offers the most return on investment there. And often if your home is okay your best strategy means no improvements necessary unless you are keeping the property a… Read more »

RJ Weiss
RJ Weiss

Thanks Liz for replying. Great combination of advice, between you and J.D.

corey
corey

Not sure if any real estate professionals have weighed in yet, so I’ll add my 2 cents as a real estate guy in the Berkeley area. There is now a “blind appraisal” process, where banks have to submit the appraisal into a database that farms the appraisal out to all the appraisers in an area. So, the banks aren’t really “in cahoots” with appraisers anymore. Before we had appraisers who specialized in an area, but now we have appriasers from all over doing appraisals in very specialized neighborhoods. Neighborhoods here in the East Bay vary drastically from block to block.… Read more »

bigmike
bigmike

A quick question… hopefully someone can help me with this. If I want to refinance my home (built in early 2008) because of lower interest rates, will all lenders require a re-appraisal? The home was valued at $275,000 at the time, and refinancing could lower my payments about $200 per month, but I’m worried that they might come in with too low of an appraisal, so that I might get stuck with PMI (which I do not currently have to pay). Thanks!

Great topic…

E
E

I suspect any reputable lender will require an appraisal. Especially under current circumstances lenders are going to be very careful about having sufficient collateral.

I would be as leery of a lender skipping the appraisal as I would of a realtor advocating skipping the inspection.

Good luck with your re-fi.

Kevin M
Kevin M

@bigmike – I’d assume you need an appraisal, but perhaps you could go through your current lender without one? My brother refinanced his home for a one-time fee a few years ago and I’m pretty sure he didn’t have to go through the full refi process. Might be worth a phone call at least.

Sam
Sam

I would expect that you would need an appraisal for a REFI in almost all markets these days. We refinanced our primary home this spring and not only was an appraisal requried it was the most detailed appriasal I had ever been present for. And we refinanced with the same lender that gave us the original mortgage. You probably can figure out, within a general range, what a prospective house is worth based on the comps in the neighborhood. Our appraisal included two or three of the comps that I had already looked at in the on-line data base as… Read more »

Liz Freeman
Liz Freeman

To bigmike and all, Actually, there are ways around the required appraisal for a refi, depending on what your original loan is. For example, FHA allows streamline refinances with no appraisal or even credit qualification. Fannie Mae and Freddie are allowing refinances under Making Home Affordable even if your value has dropped (but there is still an appraisal requirement.) You’d have to see if the savings of a lower rate would offset the MI if that became an issue. In addition, it’s getting increasingly difficult to even get approved for MI so you are right to be concerned, especially if… Read more »

Kevin@OutOfYourRut

RB (5)–in regard to the appraiser being in cahoots with the bank, to emphasize what Cory (22) said, that cozey little arrangement was formally removed this past May. Lenders must now use appraisers out of a pool, and there’s little chance of finding favorites in the process. However I would say that your point was accurate in many cases previous to the current housing problems. Michael (9)–You really do have to be careful in regard to how much you spend in repairs and improvements. Most will not get you dollar for dollar of what you put in, but something less… Read more »

David/Yourfinances101
David/Yourfinances101

I had my house appraised several years ago in anticipation of a re-fi.

I was completely dissatisfied with the results. I called another company, and they appraised my home for almost $10K more.

Go figure…

Liz Freeman
Liz Freeman

David, you don’t get to pick the appraiser either. The problem with HVCC is that first, the management companies take 40% right off the top to farm out an appraisal. So that drives the costs up a lot just to add a middleman. It does nothing to improve transparency; appraisal management companies are just as likely to pressure appraisers in order to get repeat business as anyone else with a financial stake in the transaction. In addition, the appraisers who are experienced and know the areas and earned repuatations for being professional are being squeezed out of the business by… Read more »

Shannon
Shannon

I bought a house about a month ago and the appraisal came in $7k less than the purchase price. The seller and I were fine with the purchase price, but the bank required us to lower it to the appraisal amount even though I put 20% down (which was $57k !!) and they would therefore have no risk if I defaulted. I’m wondering why they were so picky, if anyone has had the same experience?

Mike Rohrig
Mike Rohrig

Besides the obvious issues of appraiser’s competency, incentive, and knowledge there is still the point that it is an opinion. Just like each buyer, each appraiser comes in with his own bias. Valuing a home is art as much as science.

I am a Realtor and I will look at 10 to 30 homes in a neighborhood and then look at the overall area. Appraisers only have to show 3-5 comparables to make their case.

Lastly look at this article on the Freakonomics blog about appraisers for an interesting scenario.
http://freakonomics.blogs.nytimes.com/2007/04/18/arizona-appraisers-vs-zillow/

PLS
PLS

I am confused. We have a home in Des Moines area that was refinanced in 2005 and appraised at $175,000 (might have been over valued, but I purchased the house in 2004 for $165,000) at that time. The market in the area has not declined like others in the US and according to Zillow and other sites, prices have appreciated since 2005 (relatively). We are trying to refinance again. Since 2005 we have added a 4 season porch, new windows (fiberglass lifetime guaranteed), new furnace, new roof, new water heater, new exterior doors, all new flooring, redone 2 bathrooms and… Read more »

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