How Low Appraisals Effect You

Unless you’ve been living on a desert island for the past six months, you’ve probably already heard the positive news about the LA housing market. Prices are steadily rising, inventory is low, and bidding wars abound. The word is out – now is the time to buy! Unfortunately, the downside to this sudden market turnaround is that buyers are becoming more and more familiar with a pesky issue that has been plaguing the market all summer – the low appraisal.

Anytime a lender is involved with a home purchase, the buyer will be responsible for paying for an appraisal of the property – issued by an appraiser of the lender’s choice – on behalf of the lender. The purpose of the appraisal is to protect the lender against allowing a buyer to borrow more money than the home is actually worth. Ideally, the appraisal should protect the buyer as well, but in a seller’s market – where bidding wars are pushing home prices past that of the most recent sales – the appraisal can put the sale in jeopardy if it comes in below the accepted price.

There are typically three options for buyers who are saddled with a low appraisal. First, the most appealing option – the seller can agree to drop the price to match the appraisal, and the buyer gets the house at a lower price. On the flip side, the seller can refuse to drop the price at all. In this scenario, the buyer would be required to bring in a portion of the difference between the appraised price and the contract price as an increased down payment. For example: let’s say the contract price is $400,000 and the buyer agreed to a 20% down payment ($80,000) with an 80% loan balance ($320,000). If the house appraises at $350,000, then the buyer will only be allowed to borrow 80% of the appraised value ($280,000) and will be required to bring in an additional $40,000 to make up the difference. So in this example, the buyer would still buy the house for $400,00, but would now make a down payment of $120,000 with a smaller amount borrowed. The final option for a low appraisal is to come to some kind of compromise between buyer and seller in which they meet in the middle with the seller agreeing to a discounted purchase price and the buyer bringing in more cash upfront. If all else fails, the buyer has the option of walking away from the sale and losing nothing as long as he has made the appraisal a contingency of the sale in the purchase contract.

You may be asking why appraisals are coming in low at all when we are so obviously experiencing a surge in the current market. Unfortunately, appraisals are largely determined by analyzing recent comparable sales within a short distance of the subject property. When the market makes a sudden rise – especially after an extended slow period – it often takes months for the comparable sales to catch up to what is actually happening in the current market. The presence of nearby short sales and REO sales will also effect values because appraisers can not completely discount distress sales during the appraisal process. Hopefully, by this time next year, the pesky low appraisal will be a thing of the past. Until then, feel free to contact me if you have any questions about the appraisal process or the market in general!