Does a Conventional Loan Require an Appraisal?

Conventional loans are a common type of mortgage not backed by government agencies, distinguishing them from programs like FHA or VA loans. These loans are instead originated and serviced by private lenders such as banks, credit unions, and other financial institutions. A property’s value plays a significant role in real estate transactions, affecting both the borrower’s investment and the lender’s risk. This article clarifies when a conventional loan typically requires an appraisal and explores the limited circumstances where this requirement might be waived.

Understanding Property Appraisals

A property appraisal provides an unbiased professional opinion of a home’s value. This assessment is conducted by a licensed appraiser who acts as a neutral third party in the transaction. The primary goal of an appraisal from a lender’s perspective is to determine the collateral’s worth, ensuring the loan amount is justified and mitigating potential risk. If a borrower defaults, the property serves as security, and the lender needs assurance that its value adequately covers the loan.

Appraisers consider numerous factors when evaluating a property, including comparable sales of similar homes in the area. They also assess the property’s physical characteristics, such as its size, condition, and architectural style. Location is a significant factor, with proximity to amenities, school quality, and neighborhood features heavily influencing value. Market trends and economic conditions are also taken into account to determine a property’s current market value.

General Appraisal Requirements for Conventional Loans

Conventional loans generally require a property appraisal. This is largely driven by guidelines from government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, which purchase most conventional loans and set valuation standards. The appraisal serves as a risk assessment tool for the lender, confirming the property’s value supports the loan-to-value (LTV) ratio.

For new purchases, an appraisal is almost always a mandatory step. Cash-out refinances also necessitate an appraisal to establish the current market value against which new loan terms are set.

Circumstances for Appraisal Waivers

While appraisals are generally required, specific and limited circumstances may allow for an appraisal waiver on a conventional loan. These waivers permit bypassing a traditional in-person appraisal, relying instead on automated valuation models. Automated Underwriting Systems (AUS) like Fannie Mae’s Desktop Underwriter or Freddie Mac’s Loan Product Advisor can determine eligibility for such waivers. If the AUS has sufficient data, including recent prior appraisal data on file, and the loan meets specific low-risk criteria, a waiver might be offered.

Waivers are often considered for low loan-to-value (LTV) ratios, indicating substantial borrower equity or a large down payment. For instance, a down payment of at least 10% for purchases or 10% to 40% equity for refinances can increase eligibility. Streamlined refinances, particularly rate-and-term transactions without cash-out, are also common scenarios where an appraisal waiver may be granted. However, waivers are not guaranteed and are solely determined by the lender and the AUS based on various risk factors and property data.

Addressing a Low Appraisal

If a required appraisal comes in lower than the agreed-upon purchase price, it creates an “appraisal gap” and has direct implications for the loan. Lenders will only extend a mortgage based on the appraised value or the purchase price, whichever is lower. This means the buyer must cover any difference if the appraisal is insufficient. The difference must then be addressed by the buyer or through renegotiation.

Several options are available to the buyer when facing a low appraisal. The buyer can negotiate with the seller to lower the purchase price to match the appraised value. Another common solution is for the buyer to cover the difference in cash, bringing additional funds to closing beyond their original down payment. Buyers may also attempt to contest the appraisal by providing additional comparable sales data, though this is rarely successful. If the purchase agreement includes an appraisal contingency, the buyer might have the option to walk away from the deal without penalty.