How the appraisal process can derail your mortgage approval
When you apply for a mortgage, there are many factors that affect your approval and the amount you can borrow. These include your income, credit score, and down payment. But they also include something that is completely beyond your control: the valuation of your home.
Lenders require an appraisal so that a professional can determine the home’s value. They want to make sure that the house is valued high enough that it can serve as sufficient collateral to secure the loan. Unfortunately, if your appraisal is too low, you might not be able to borrow the amount you need for the home you want to buy.
How an Appraisal Could Affect Your Ability to Get a Home Loan
Mortgages are secured loans and the home must be worth enough so that the lender does not suffer financial loss if they have to foreclose.
In fact, lenders generally prefer that you put down a down payment of at least 20% so that you don’t lend you the full value of the house. While you don’t necessarily have to, you’ll usually end up paying private mortgage insurance (PMI) if you put in less than 20%.
The amount you can borrow, relative to the value of the house, is called the loan-to-value ratio. But the home’s valuation – not necessarily the amount you pay for the home – determines “value” when your loan-to-value ratio is determined.
For example, suppose you are bidding $ 400,000 on a home you like and planning to put down $ 80,000 down payment. If the home is valued at $ 400,000, you would have an 80% loan-to-value ratio and you wouldn’t have to pay for the PMI.
If the appraiser determines that the house is only worth $ 350,000, you have a problem. If you pay the $ 400,000 you offered and put in $ 80,000 as planned, you will borrow $ 320,000 to buy a house that the lender considers to be worth only $ 350,000.
Your loan to value ratio in this case would suddenly be 91% and you would have to pay PMI. And in some cases, if your loan-to-value ratio is too high, the lender may not be willing to give you a loan at all.
What if you end up with a bad review?
If your home isn’t valued as much as you hoped, you have several options:
- Appeal your assessment. You can ask the rater to take another look. This can sometimes lead to a higher appraised value, especially if you are indicating why some of the comparable properties used by the appraiser were not actually comparable or if you are suggesting alternative properties that might show your home is worth more.
- Try to get the loan anyway. If the low valuation lowers your loan-to-value ratio, you may not be approved. Or you may end up being approved but be required to pay PMI.
- Make a larger down payment. In our example above where you offered $ 400,000 and the house appraised for only $ 350,000, you could put in some extra money to make up the difference.
- Renegotiate your contract with the seller. If you made an offer conditional on obtaining financing and cannot get loan approval due to the low appraisal, you would be able to opt out of the contract. You can use this as leverage to try to renegotiate the price. The seller may be willing to accept a lower offer if the appraisal is correct and its value is truly lower than the offer, as they would otherwise be likely to experience this issue again.
- Stay away from the purchase. But if you don’t have a clause in your offer contract allowing you to do so, it could mean losing your deposit.
- Apply for financing from another lender. The new lender will likely want their own valuation done, and the valuation could be higher. This is a risky strategy, however, as you will have to pay for another appraisal and you could end up in the same situation. But you could look for a new lender who might allow a higher loan-to-value ratio, so you’ll still end up closing the loan even if the appraisal is low again.
Obviously, ending up with a low rating is not ideal. But you have options if that happens. You just need to make sure you explore them ASAP to overcome that big bump in the road to homeownership.