Appraisals

A property appraisal is critical to the mortgage loan process, because it analyzes the collateral which will secure a mortgage. The appraisal provides the underwriters with an in-depth look at the property and attempts to rigorously estimate a fair market value. It is important that this value be as true a representation of value as possible. Inflated appraisal values contribute to possible negative equity for homeowners and huge losses to the lenders due to foreclosures. A prospective buyer does not want to overpay for a property, nor does the lending institution want to finance a mortgage based on insufficient collateral. Therefore, an appraisal is necessary for all purchase transactions to ensure the purchase price is not inflated, and for most refinance transactions (excluding streamline FHA refinances). The appraiser must be licensed and in good standing with the appropriate regulatory agencies.

The following is a basic break down of an appraisal.

  1. Identification and description of the subject property and the property rights. These descriptors convey what type of property the collateral is and the property rights.
  2. Transaction type : Purchase or Refinance.
  3. Location (Suburban, Rural or Urban) and current use. Typically, there is less demand for rural properties, and thus the property location is an important classification in many mortgage decisions.
  4. Neighborhood Analysis provides a clear description of the area including: development and growth rates, if the neighborhood is experiencing increasing, stable or declining values, inventory supply and demand along with how long the average home takes to sell, predominant occupancy (a majority of renters may mean that the properties are not well kept), price range and predominant price, age range of properties and the predominant age as well as the site analysis. Zoning, Utilities (public or private), Lot descriptors (size, shape and topography), Flood Hazard designation (which if deemed in flood area, then flood insurance is required), actual and effective age, gross living area (square footage) not including any finished basement.

Once the appraisal appointment is set, the appraiser inspects the property. He/she takes measurements, takes interior and exterior photos, photos of the street and of benchmark properties - called comparable properties, or "comps." The appraiser must log improvements to the property and land. Additionally, it is incumbent on the appraiser to exercise due diligence in analyzing the structural integrity of the dwelling and note any deficiencies or disrepair.

Most all appraisals are completed in "as is condition" therefore the appraiser must document the condition of the property as specifically as possible. Any repairs that need to be made must be listed and a "cost-to-cure" provided. This cost-to-cure is an estimate of the cost to remedy any disrepair that if left unattended could jeopardize the collateral. Many times the cost to cure is subtracted from the market value and underwriters will stipulate these repairs be made before releasing funds.

Once the physical inspection has been made, the data crunching begins. The appraiser must research and compile additional data from public records specific to the comps. Most lenders require at least three comps, however it is not unusual for the underwriters to request more to help solidify the value especially if questionable.

Comps are appropriate if:

The appraiser creates a table using the subject property as a reference. He/she then compares the subject property to the comps' sales prices, less any seller concessions - and makes line adjustments for the variations between the subject and the comps. These adjustments are then totaled for a relative sales price for each comp (relative to the subject property). Gross adjustments cannot exceed 25% of the original sales price per comp. The relative sales prices are then averaged to calculate the final sales estimate.

There are three common value approaches, all used in tandem to derive a fair market value:

  1. The cost approach is an estimation of what it would cost to replace or reproduce the property, plus improvements, without the physical deterioration, the functional obsolescence and the economic obsolescence.
  2. The sales approach references other "benchmark" properties with similar size, quality and location that have been recently sold.
  3. The income approach to determining value is of primary importance in ascertaining the value of income producing properties and has little weight in residential properties. This approach provides an objective estimate of what a prudent investor would pay based upon the net income the property produces.

After thorough analysis of the general and specific data gathered from the market, the appraiser produces a final estimate of value.

As you can see, an appraisal is a subjective measure of the property's value. However, a diligent and objective appraiser (with no undue pressure to achieve a certain value) and strict appraisal guidelines - can produce as accurate an estimate of this collateral as possible. Once an appraisal is completed and sent to the lender, it is the borrower’s right to request a copy of the appraisal. They are good documents to keep on file, they can serve to settle an estate, establish the replacement cost for insurance if needed, or to contest high property taxes.