The appraisal is one of those parts of the mortgage process that can make buyers nervous because it feels a little out of their hands. You made an offer. The seller accepted it. Everyone wants to move forward. Then the lender still needs an appraisal.
That can feel like one more hurdle, but the reason is pretty straightforward. The lender is lending money against the property, so the lender needs an independent opinion of the property's value.
What an appraisal is
An appraisal is an opinion of value prepared by a licensed or certified appraiser. In a mortgage transaction, the appraiser is not deciding whether the home is a good deal for you. The appraiser is estimating value for the lender's collateral decision.
That distinction matters. You may love the home, the neighborhood, the kitchen, and the backyard. The appraiser is looking at market value based on the property and comparable sales.
Why lenders require appraisals
When a lender makes a mortgage loan, the home is the collateral. If the borrower does not repay the loan, the lender's ability to recover the debt depends partly on the value of the property.
That's why the appraisal matters even when the buyer and seller already agreed on a price. The contract price tells us what this buyer and seller agreed to. The appraisal gives the lender an independent value opinion.
How appraisers estimate value
For most residential purchase transactions, buyers hear the most about the sales comparison approach. The appraiser looks at similar homes that have sold recently and makes adjustments for differences such as size, condition, location, lot, features, and market activity.
Other approaches may be used in certain situations. The cost approach considers what it might cost to replace or reproduce the improvements, adjusted for depreciation and land value. The income approach is more common when the property is being evaluated based on income it can generate.
What the appraiser looks at
The appraiser may consider the home's size, layout, condition, location, lot, age, features, upgrades, and comparable sales. The appraiser also may note obvious condition issues that affect value or loan eligibility.
But the appraisal is not the same thing as a home inspection. An appraisal is primarily about value. A home inspection is primarily about condition. A clean appraisal does not mean the home has no defects, and a detailed inspection does not determine the lender's value.
What if the value is lower than expected?
If the appraised value is lower than the contract price, the lender generally bases the loan-to-value calculation on the lower of the purchase price or the appraised value. That can change the amount the lender is willing to lend.
A low appraisal does not automatically end the deal. The buyer and seller may renegotiate. The buyer may bring more money. The loan structure may change. Or the buyer may have the ability to cancel, depending on the contract.
What buyers should remember
The appraisal is not a pass/fail grade on the home. It's one part of the lender's review. The best thing buyers can do is understand what the appraisal is for before it becomes a last-minute surprise.
If you're worried about appraisal value, talk with your lender and real estate agent early. The right strategy depends on the contract, the loan program, your available cash, and whether the seller is willing to negotiate.