When you sell or buy a home, the sales price and appraisal value don’t always match up, and this discrepancy can lead to a change in the purchase price or dissolve the deal altogether. Therefore, it’s essential to understand how these numbers can differ and how the sale can still proceed when there is a difference.
How Does Appraised Value Differ from Sales Price?
A home’s appraised value states what the property is worth, while the sales price is what a buyer is willing to pay for the home in the current market, based on supply and demand. As a general rule of economics, when something is in high demand, prices tend to go up. When there’s less demand, prices tend to go down.
How Are Home Sales Prices Determined?
The housing market is, of course, influenced by the fluctuations of supply and demand, as well as current interest rates.
When there are fewer homes on the market, buyers face increased competition and are willing to pay more for their home purchase. Additionally, when interest rates are low, buyers can save money on their mortgage, which brings more homebuyers into the market, and that can also increase demand—and therefore home prices.
On the other hand, when there are more sellers than buyers and supply is greater than demand, home prices tend to go down. This scenario can happen when interest rates are higher and mortgages become less affordable, so there are fewer buyers entering the market.
How Is a Home’s Appraisal Value Determined?
When a home goes under contract between a seller and buyer, the homebuyer’s mortgage lender requires an appraisal to make sure they are not issuing a home loan amount for more than what the house is actually worth. This is when the appraisal process begins.
A licensed appraiser acts as a neutral third party to assess the value of a home. The appraiser examines the features of the property, like age of the home, square footage, number of bedrooms, number of bathrooms, and lot size. Additional features such as upgrades to the home may be included in the assessment of the home. The appraiser then uses the evaluation of the property and comparable homes to determine the home’s appraised value.
Comparable homes are similar homes in the same area that have been sold recently, with the same number of bedrooms, bathrooms, and square footage. Different factors, like an extra half bath, might add value. On the other hand, an old roof or a home in poor condition may subtract from the appraised value.
What Happens When the Appraised Value and Sales Price Don’t Match?
Let’s look at the different scenarios that could happen after the appraiser completes their home appraisal report.
If the appraised value matches the purchase price, which is common, then the sale proceeds as planned.
But suppose the appraised value comes in higher than the sales price. In that case, the buyer is in a good position, as it means that they’ve agreed to pay the seller less than the home’s market value.
The mortgage amount does not change, because the selling price will not increase to meet the appraised value, and the buyer has instant equity in the home.
There’s also the scenario where the home appraisal comes in below the sales price. This can happen during a hot housing market, especially when bidding wars can drive up buyer offers on the home.
When this happens, the appraised value can very well be lower than the agreed-upon purchase price, which can change the terms of the mortgage.
However, there are ways to get around this scenario and still proceed with the sale.
First, it’s essential to understand that because of loan guidelines, lenders do not exceed the appraised value when issuing a mortgage, and therefore they use the appraised value to calculate the borrower’s loan-to-value (LTV) ratio.
For instance, let’s say that the seller accepted the buyer’s offer to purchase the house for $200,000, and the maximum LTV for the buyer’s loan is 97%, or $194,000. If the home appraises for only $190,000, then the buyer will need to make up the $10,000 difference.
In this case, the buyer has a few options:
- The buyer can pay the difference out of their own pocket.
- The buyer may be able to restructure their financing.
- The buyer can negotiate with the seller to lower the purchase price to match the appraised value.
- The buyer can request a reconsideration of the appraisal value if they believe the report is inaccurate.
- The buyer can terminate the purchase contract and get their earnest money deposit refunded, assuming that there was an appraisal contingency in the contract. If there was no appraisal contingency, the buyer risks losing their earnest money.
When buying a home, remember that the property’s appraised value is what impacts your loan amount and can make or break the deal. Therefore, it’s important to be aware of the differences between the sales price vs. appraised value and plan accordingly in case there is a discrepancy.