Appraised Value - What if it's low?

Appraised Value – What if it’s low?

This has been a week of what I will call appraisal “mishaps.” There were a total of three and they quite possibly capture the moving target that is appraised value. Suffice it to say, before you read on these aren’t “happy” stories, but they are a recent take on the topic.

Case 1 – Refinance Funk

In 2010, my borrower bought a nice single family home (SFR in industry parlance, if you like that sort of thing) on the North side of Chicago. When he bought the house, we were surprised (well, I was surprised) to see that the house appraised for more than the contract purchase price. This nice upside surprise was encouraging for my borrower and he felt justifiably smart for agreeing to pay less than his house was worth.

Later in 2010, rates dropped (this, I think, is pretty well documented) and I helped him refinance his mortgage. By then, it was no miracle that the house again appraised for more than he originally paid and was about the same as the appraisal from when he purchased. All good.

After the second closing, my borrower undertook some improvements to his home. I believe he remodeled the kitchen, the bathrooms and the floors. Perhaps, he did other things, but the things he did made the house more modern (contemporary? I always confuse those two) and contributed what most people would believe to be value to the home. Skip ahead to July 2011. Rates recently dropped and my borrower (who is a willing adherent to my theory that an ARM is good) decided to refinance again. He had spent money upgrading the house and picking up a monthly savings with no costs (call me about no cost refinancing) seemed prudent.

We started the process as always, including, ordering an appraisal. When the appraisal came back, we were shocked to find that the value had dropped by more than the cost of his new kitchen and bathrooms. Aghast, we showed the appraiser errors in the report and additional comps (comparable sales of similar homes in the area) and asked that he look at things again. The appraiser did make some changes to the report and did raise the value a bit. In the end, though, he ignored appropriate comparable sales and gave an appraised value that prevented my client from refinancing on the terms we’d expected. This unavoidable disappointment defied the recent history on this property.

Case 2 – Appraised value less than purchase price

There was a time not so long ago when the appraised value of nearly every purchase came back at the purchase price. Stunned buyers would ask how that could be. Generally, the answer was that the appraiser was allowing the market price, i.e., what an arms-length buyer was willing to pay a seller for the home, to control. It was the rare home that appraised for more than the purchase price. When one did, my borrower always assumed they had made a great deal. The thing is, a higher appraisal means nothing, because to the extent it is a gain, it is a paper gain.

On two loans I worked on recently, the appraisals came in below purchase price. When this happens (and these loans were no exception), fireworks ensue. Out come the torches and pitchforks. Typically leading the angry mob are the Realtors who likely worked very hard to put the deal together. Then comes my borrower who may have gone through rounds of negotiation to get to the price they agreed to pay. Universally, the borrowers ask (after they finish calling me names I won’t reprint here, but not really) “what do we do now?” The ways to respond typically boil down to:

1) Walk away from the deal, take your earnest money and start your home search over
2) Go back to the seller and renegotiate
3) Add more money to your down payment
4) Keep things as they are and pay PMI (if the appraised value puts you at less than 20% of purchase price) or not if you are still fine with the planned down payment

In today’s market, with the decline in real estate prices and the belief they may decline further still, most people try options 1 and 2. I have only once seen someone try option 3 (they had fallen in love with the home) and have never seen someone elect to take PMI. The sad truth for the sellers of these properties is that there are a number of available homes on the market now. If things don’t work out, the buyer may just take his ball and go . . . to a different home.

For borrowers who are buying, these appraisals underscore the importance of surrounding yourself with seasoned professionals. I mean me, of course, but also a good realtor who understands the market where you are looking and a lawyer who will aggressively protect you and your mortgage contingency.

But as I said, I mean me as your mortgage professional too. So email or call, 847-902-8030. I look forward to your call.

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