Low Appraisal Needn't Derail Home Loan

The term “low appraisal” doesn't mean an appraiser’s opinion of a home’s value is faulty or incorrect. Rather, it means the valuation of the home was lower than the home seller, buyer, REALTOR® or lender expected it would be. "Low," in this context, is a relative term.

Low appraisal may alter pricing or terms
A low appraisal can mean that the lender won't approve the borrower’s loan. To understand why, suppose a homeowner had a $200,000 first mortgage, believed his home was worth $250,000 and wanted to obtain a $40,000 home equity loan. But then suppose the appraiser valued the home at only $190,000. The lender likely would decline the new loan since the homeowner already owes more than the appraiser believes the home is worth.

In other cases, the lender may approve the loan, but adjust the interest rate or terms. Suppose a home buyer wanted to borrow $140,000 to buy a home she believed was worth $200,000. The lender quoted an interest rate of 6.25 percent on the assumption that the loan-to-value ratio would be 70 percent. But then suppose the appraiser valued the home at only $175,000. The loan might be approved, but the interest rate might be higher to compensate the lender for the additional risk of the 80 percent loan-to-value ratio.

Seller and buyer may renegotiate purchase price
If an appraisal comes in less than the contracted purchase price and the contract contains an appraisal contingency, the buyer can choose not to purchase the home because the contingency gives the buyer the right to exit the contract if the appraisal isn't acceptable to him or her. In this case, the buyer's earnest money deposit typically would be returned to the buyer. Appraisal contingencies usually have a timeframe, so the buyer has only a limited number of days to approve or disapprove the appraisal.

If the contract didn't contain an appraisal contingency, the buyer might be obligated to purchase the home at the contracted price despite the low appraisal. In that case, the lender would base the loan approval on the appraised value, not the purchase price, and buyer would need to pay the additional amount in cash. If the buyer were unable to close the transaction, his or her deposit likely would be forfeited to the seller.

Alternatively, in either situation, the buyer might exit the contract through another contingency or ask the seller to reduce the purchase price. The seller might agree to do so for the sake of closing the transaction, though he or she typically would have no obligation to alter the price once the contract had been signed. When an appraisal comes in low, the contract is often renegotiated to accommodate both the buyer's and seller's needs, although this is not always the case.

Home improvements don’t return full value
Appraisals sometimes fall short of expectations because homeowners tend to assume that home improvements will return a dollar-for-dollar increase in value. That’s rarely the case. Most improvements recoup only 65-85 percent of the cost, on average, which means a $10,000 project might add $6,500 to $8,500 to the value of the home.

Property appraisals aren't scientific, yet state-licensed appraisers are required to make independent judgments that aren't influenced by anyone else’s opinion. If an appraisal appears to be wildly faulty, the lender may be willing to order a second opinion, depending on the specific circumstances.