What Is the Main Purpose of an Appraisal in a Home Sale?

A home appraisal provides an independent, professional assessment of a property’s fair market value within a home sale. A licensed appraiser performs this evaluation, serving as an objective valuation for all parties. It offers a reliable estimate of what a willing buyer would pay and a willing seller would accept.

Lender’s Role in Requiring an Appraisal

The primary reason an appraisal is required in a home sale, particularly for financed purchases, is to protect the lender’s investment. Lenders view the home as collateral for the mortgage loan they provide. An appraisal confirms that the property’s market value adequately supports the loan amount, mitigating the financial institution’s risk.

Lenders will not approve a mortgage for an amount exceeding the appraised value. This ensures that if a borrower defaults, the lender can likely recover their investment by selling the property. Without a satisfactory appraisal, lenders are unwilling to fund the mortgage. The borrower usually pays the appraisal fee, though the lender orders the appraisal and owns the report.

Key Factors in Property Valuation

Appraisers determine a property’s fair market value primarily using the sales comparison approach. This method analyzes recently sold properties, known as “comparables” or “comps,” that are similar to the subject property. These comparable sales are located in the same neighborhood or a similar area and have recently closed, often within the last six months.

Appraisers consider property characteristics such as square footage, number of bedrooms and bathrooms, overall condition, age, and significant upgrades. They also evaluate the property’s location, including proximity to amenities, school districts, and neighborhood desirability. Current market conditions, like supply and demand, interest rates, and local economic trends, also influence the valuation. An appraisal is distinct from a home inspection, which focuses on the property’s structural and mechanical condition.

Appraisal Results and Their Implications

The outcome of a home appraisal can impact the transaction. If the appraised value is equal to or higher than the agreed-upon sale price, the transaction proceeds without complications, as the lender is comfortable with the loan amount relative to the property’s value. A higher appraisal can even provide the buyer with instant equity.

However, if the appraised value comes in lower than the contract price, it creates an “appraisal gap” and presents challenges. Lenders will only finance up to the appraised value, meaning the buyer would need to cover the difference in cash. For example, if a home is under contract for $400,000 but appraises at $350,000, the buyer would need an additional $50,000 in cash beyond their down payment.

In such a scenario, several options emerge. The buyer and seller can renegotiate the purchase price to match the appraised value, or the buyer may choose to bring more cash to closing to cover the gap. A common protective measure for buyers is an appraisal contingency clause in the purchase contract. This clause allows the buyer to renegotiate the price or, if an agreement cannot be reached, walk away from the deal and retain their earnest money deposit without penalty. Without this contingency, the buyer might be legally bound to purchase the home at the original price or risk losing their earnest money.