Bank appraisals have been a normal part of the real estate process for many, many years. They are also one of the most important parts of processing for your lender.
Let’s face it – you may have offered $950,000 for the home of your dreams, but if that home is really only worth $900,000, the bank has a lot to lose if you default on your mortgage payments. Banks want to make sure that the money they lend you is protected and appraisals are one of the ways they do that.
How an Appraisal Works
The appraisal happens after an offer to purchase has been accepted, but before the mortgage is advanced and the Buyer takes possession. Pre-pandemic, appraisers had to visit a property in person in order to determine its value. During COVID, however, appraisers can view a property either virtually (using photos) or in-person.
Appraisers are mandated to use very recent comparables – usually properties that have sold in the last 60 days. Appraisers do not judge a home’s value based on what happened before that, nor do they make predictions of what can happen.
Who pays for an appraisal? This really depends on a few factors, most notably if the appraisal was done by a bank, prime lender, or alternative prime lender. Banks can pick up the cost of appraisals or they can hide this cost in the advance of the mortgage. If a bank gets an “auto valued” appraisal i.e. no appraiser had to visit the property, that’s usually hidden deep in the mortgage commitment and costs $99. If you’re working with a mortgage broker, the good ones always pay for the appraisal (either up-front OR at time of closing).
Good to know: The goal of a bank appraisal is to justify how much a Buyer has agreed to pay for a home, not determine the true value of a home. Appraisals will never come in over the agreed-to price. If you got a deal, don’t expect the bank appraisal to come in higher than what you offered.
What happens if the bank appraisal comes in at less than what you offered?
Unfortunately, sometimes, the bank’s appraiser doesn’t think a home is worth what a Buyer and Seller agreed it was worth. We see this sometimes during highly competitive markets where bidding wars are the norm or when the market shifts downwards rapidly and a lot of sales are still pending and have not been appraised. (like in 2017).
A Buyer offers $950,000 for a house during a bidding war, but the bank appraiser thinks that the house is only worth $900,000. This means that:
- The bank will now only approve a mortgage based on a value of $900,000. So if they were willing to lend you 80% of the value of the home – that now means you’ll get a mortgage of $720,000 instead of $760,000.
- To make up that $40,000 difference, the first thing they’ll do is look at your deposit – so in this example, instead of your $190,000 downpayment, they’ll assume you have a $150,000 downpayment and that the other $40K is making up the difference between what you paid and the appraised value. Because the downpayment is now considered by the bank as 150K – you now have a 16% downpayment and will have to pay CMHC insurance (which is required when your downpayment is less than 20%) and, is ONLY possible if your purchase price is under $999,999.99. Furthermore, going from a 20% downpayment to a CMHC-insured mortgage will make it harder to qualify for the mortgage, and the amortization period will be limited to 25 years. However, it is a way out of this unfortunate situation.
- If your deposit was 5% and the property doesn’t appraise, you may no longer qualify for that mortgage and may have to get creative.
When an appraisal value doesn’t equal how much a Buyer paid for a property, you’ve got a few options:
- Find another lender who sends in another appraiser and hope that the second appraisal value comes in at what you offered.
- Your agent can argue the comparable sales that the appraiser used to determine the value (note: this is rarely successful). This can mean extra costs and fees and is a very hard road to navigate because most lenders won’t budge on value. It’s worth a shot, however.
- Wait. In a rising market, you can wait for new sales to close that will help justify the price you paid, and have the property re-appraised before closing. This only works if you have a relatively long closing period.
- Come up with the $$$ for the difference. Beg, (don’t steal) or borrow the funds to make up the difference.
How can you protect yourself from low bank appraisals?
There are a few things you can do to protect yourself from a low bank appraisal:
- Make sure your REALTOR takes an active role in educating the appraiser and directing him/her to recent comparable sales. They may be able to help persuade the appraiser’s opinion.
- Have a financing condition and insist that your lender performs the appraisal during the conditional period. It’s never fun to find out the week before you take possession that the bank’s appraiser doesn’t think your house is worth what you offered and that you need to come up with more money. Better to know your options when you still have time to make alternative arrangements. Note that if you’re buying in a competitive market, you may have to sort out your financing in advance of the offer and may not be able to include a financing condition. [Related: How to Win a Bidding War]
- Don’t over-pay for the home in the first place. The bank’s appraisers are going to be looking at the same comparable sales as you and your REALTOR – make sure you truly understand how the home compares to recent sales in the immediate neighbourhood.
- Have a contingency fund. There are hundreds of reasons why you should have available cash and/or credit available when buying a home – trust me, there are always unexpected costs. If the bank appraiser under-estimates what the house is worth by $5,000, your least stressful option is to make sure you have access to extra money to fund the difference. And remember to never borrow as much as a lender is willing to give you! (Unless you want to be a slave to your mortgage.)
- Have a Plan B. Talk to your REALTOR and mortgage broker or bank before you put in an offer and have a backup plan if the property doesn’t appraise. In a fast-rising market, Buyers pay more for a home than the last comparable sale – that’s what makes it a rising market. Sometimes it takes banks and the appraisers time to catch up with what’s happening in the market.