How Does an Appraisal Affect a Mortgage?
Unpack the critical link between property appraisals and your mortgage. Understand how value impacts loan approval, terms, and your homeownership journey.
A mortgage appraisal provides an independent, professional opinion of a property’s market value. This assessment is a fundamental component of the mortgage lending process, serving as a safeguard for the lender. Its purpose is to confirm the property’s value, which acts as collateral, justifies the requested loan amount. Lenders rely on this valuation to ensure they do not loan more money than the home is worth.
Understanding the Mortgage Appraisal Process
A licensed, independent appraiser conducts the mortgage appraisal, typically ordered by the lender after a purchase contract is executed. To determine the property’s market value, the appraiser considers several factors, including its physical condition, square footage, number of bedrooms and bathrooms, and overall lot size.
The property’s location is also a significant consideration, encompassing neighborhood appeal, proximity to amenities, and the condition of nearby properties. The appraiser’s method involves analyzing comparable sales, often called “comps,” which are similar properties recently sold in the area. An on-site inspection documents the home’s characteristics and any visible defects before a detailed valuation report is compiled.
Direct Impact on Loan Approval and Terms
The appraised value directly influences the loan-to-value (LTV) ratio for mortgage lenders. This ratio compares the loan amount to the property’s appraised value. Lenders use the lower of the appraised value or the sale price to determine the maximum loan amount they will provide.
Ideally, the appraised value equals or exceeds the sale price. In this case, the lender views the property as sufficient collateral for the agreed-upon sale price, and the loan typically proceeds as planned. This ensures the lender’s risk is mitigated and the buyer’s financing remains stable.
Conversely, if the appraised value is lower than the sale price, it creates an “appraisal gap.” Lenders will only finance a loan up to a certain LTV of the appraised value, not the higher sale price. This reduces the maximum loan amount available to the buyer, directly impacting their financing.
When an appraisal gap occurs, the buyer faces several financial implications:
They may need to cover the difference between the appraised value and the sale price out-of-pocket, increasing their required cash for the down payment and closing.
The buyer can attempt to renegotiate the sale price with the seller to match the appraised value or a compromise.
If a resolution cannot be reached and the purchase agreement includes an appraisal contingency, the buyer may have the option to terminate the deal without losing their earnest money deposit.
A low appraisal can also affect Private Mortgage Insurance (PMI) requirements; if the lower appraised value results in a higher LTV ratio (above 80%), PMI might become necessary, adding to the buyer’s monthly housing costs.
Addressing Discrepancies and Next Steps
If a low appraisal is received, the borrower or their agent should thoroughly review the report. This review should focus on identifying factual errors, such as incorrect square footage, room counts, or property descriptions. It is also important to check for overlooked comparable sales that might have supported a higher valuation.
If discrepancies or errors are found, a “reconsideration of value” (ROV) can be requested from the lender. This request requires compelling new information, such as more suitable recent comparable sales, unlisted property improvements, or documented factual inaccuracies. The lender will then submit this information to the appraiser for review.
Beyond disputing the appraisal, buyers have other options. Negotiating with the seller to lower the sale price to align with the appraised value or to meet in the middle is a common strategy. If the buyer has sufficient liquid assets, they might choose to bring additional cash to closing to cover the appraisal gap. As a last resort, if the contract includes an appraisal contingency and no other solution is feasible, the buyer may decide to walk away from the transaction.
Broader Implications for Homeowners
Appraisals extend their relevance beyond the initial home purchase, impacting various financial aspects for homeowners. When refinancing a mortgage, an appraisal is typically required to determine the property’s current market value. This valuation directly affects the maximum loan amount available for the new loan and helps establish the new LTV ratio, influencing interest rates and loan terms.
For homeowners seeking home equity loans or lines of credit (HELOCs), an appraisal establishes the property’s current market value. This allows lenders to calculate the available equity that can be borrowed against, as the loan amount is based on a percentage of the home’s appraised value. Additionally, a new appraisal can be used by homeowners to demonstrate sufficient equity, typically 20% to 22%, to remove Private Mortgage Insurance (PMI) from their existing mortgage, potentially reducing monthly payments.