What’s an appraisal, why do you need it, and what happens if it comes in short?

Let's talk about the appraisal process- what it means, why it’s essential, and what happens when there’s an appraisal shortage. Whether you’re a buyer purchasing with financing, a seller accepting anything other than an all-cash offer on the sale of your home, or even if you’re refinancing your home, an appraisal is going to be an important part of the process.

An appraisal helps determine the fair market value of a home. It’s a value that’s determined by an unbiased third party to ensure that both the lender and the buyer are paying a fair price for the home. In other words, it’s a way to protect the buyer from paying too much while also protecting the bank from lending more than it can recover if the buyer were to default on the loan.

Now an appraisal is not the same thing as a CMA or comparative market analysis. A lot of people confuse the two, but they’re actually two very different things that serve different purposes. A CMA is performed by a real estate agent; it’s usually done before putting a home on the market for the purpose of determining the market value and listing price of a home. On the other hand, an appraisal doesn’t happen until after the home goes under contract. The appraisal is ordered by the bank and performed by a licensed appraiser for the purpose of making sure the bank isn’t over-lending on the property.  Keep in mind that what a bank is willing to loan and what a buyer will pay are two different things.

After the buyer falls in love with and makes an offer on a home, the seller accepts (which may be after some negotiations) the home goes under contract. Typically, the buyer has their inspections and negotiates any repairs, and then after the inspection period ends, the buyer gives the lender the green light to order the appraisal. The appraisal is paid by the buyer and usually costs between $300 and $500.

The lender doesn’t get to choose the appraiser. The appraiser, by law, is a third party who gives an independent, unbiased, professional opinion of the market value of the home. The appraiser will visit the property in person and put together an appraisal report, which in addition to the property’s fair market value, includes a number of pertinent things regarding the property specifics.

According to CoreLogic, roughly 20% of home appraisals in 2021 came in below the contract price. In a more balanced market, that number hovers around 10%. What does that mean? It means the appraiser has determined that the value of the home is less than the contract price that the buyer and seller have agreed upon.

So what happens when an appraisal comes in short? There are a few options: the buyer can cover the difference between the appraisal amount and the contract price if they have the ability and willingness to do so, the seller can lower the price to the appraised value, or they can meet somewhere in the middle with the buyer covering part of the difference and the seller covering the other part. If the buyer and seller can’t reach an agreement, then either party can cancel the contract.

Bottom line, short appraisals are a reality in today’s competitive market, so it’s important that you understand what it means and what your plan of attack will be in the event the appraisal comes in short. Have a discussion with your agent about the appraisal process before a short appraisal is even presented.