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Consumer Resource Area
- What Is An Appraisal
- Frequently Asked Questions (FAQ's)
- How To Prepare For Your Appraisal
- Appraisal Myths
- About PMI
What Is An Appraisal
A home purchase is the largest, single investment most people will ever make. Whether it's a primary residence, a second vacation home or an investment, the purchase of real property is a complex financial transaction that requires multiple parties to pull it all off.
Most of the people involved are very familiar. The Realtor is the most common face of the transaction. The mortgage company provides the financial capital necessary to fund the transaction. The title company ensures that all aspects of the transaction are completed and that a clear title passes from the seller to the buyer.
So who makes sure the value of the property is in line with the amount being paid? There are too many people exposed in the real estate process to let such a transaction proceed without ensuring that the value of the property is commensurate with the amount being paid.
This is where the appraisal comes in. An appraisal is an unbiased estimate of what a buyer might expect to pay - or a seller receive - for a parcel of real estate, where both buyer and seller are informed parties. To be an informed party, most people turn to a licensed, certified, professional appraiser to provide them with the most accurate estimate of the true value of their property.
The Inspection
So what goes into a real estate appraisal? It all starts with the inspection. An appraiser's duty is to inspect the property being appraised to ascertain the true status of that property. The appraiser must actually see features, such as the number of bedrooms, bathrooms, the location, and so on, to ensure that they really exist and are in the condition a reasonable buyer would expect them to be. The inspection often includes a sketch of the property, ensuring the proper square footage and conveying the layout of the property. Most importantly, the appraiser looks for any obvious features - or defects - that would affect the value of the house.
Once the site has been inspected, an appraiser uses two or three approaches to determining the value of real property: a cost approach, a sales comparison and, in the case of a rental property, an income approach.
Cost Approach
The cost approach is the easiest to understand. The appraiser uses information on local building costs, labor rates and other factors to determine how much it would cost to construct a property similar to the one being appraised. This value often sets the upper limit on what a property would sell for. Why would you pay more for an existing property if you could spend less and build a brand new home instead? While there may be mitigating factors, such as location and amenities, these are usually not reflected in the cost approach.
Sales Comparison
Instead, appraisers rely on the sales comparison approach to value these types of items. Appraisers get to know the neighborhoods in which they work. They understand the value of certain features to the residents of that area. They know the traffic patterns, the school zones, the busy throughways; and they use this information to determine which attributes of a property will make a difference in the value. Then, the appraiser researches recent sales in the vicinity and finds properties which are ''comparable'' to the subject being appraised. The sales prices of these properties are used as a basis to begin the sales comparison approach.
Using knowledge of the value of certain items such as square footage, extra bathrooms, hardwood floors, fireplaces or view lots (just to name a few), the appraiser adjusts the comparable properties to more accurately portray the subject property. For example, if the comparable property has a fireplace and the subject does not, the appraiser may deduct the value of a fireplace from the sales price of the comparable home. If the subject property has an extra half-bathroom and the comparable does not, the appraiser might add a certain amount to the comparable property.
In the case of income producing properties - rental houses for example - the appraiser may use a third approach to valuing the property. In this case, the amount of income the property produces is used to arrive at the current value of those revenues over the foreseeable future.
Reconciliation
Combining information from all approaches, the appraiser is then ready to stipulate an estimated market value for the subject property. It is important to note that while this amount is probably the best indication of what a property is worth, it may not be the final sales price. There are always mitigating factors such as seller motivation, urgency or ''bidding wars'' that may adjust the final price up or down. But the appraised value is often used as a guideline for lenders who don't want to loan a buyer more money that the property is actually worth. The bottom line is: an appraiser will help you get the most accurate property value, so you can make the most informed real estate decisions.
Fequently Asked Questions
What is an appraisal?
What does an appraiser do?
Why would a person need a home appraisal?
What is the difference between an appraisal and a home inspection?
What is the difference between an Appraisal and a Comparative Market Analysis (CMA)?
What does the appraisal report contain?
After completing the report, what assurance is there that the value indicated is valid?
How are appraisers certified?
Who do appraisers work for?
Where does an appraiser get the information used to estimate value?
Why do I need a professional appraisal?
What exactly is PMI and how can I get rid of it?
How do I get ready for the appraiser?
What is ''Market Value?''
Who Actually Owns the Appraisal Report?
Which home renovations add the most to the price?
What is an appraisal? Back to top
An appraisal is a thought process leading to an opinion of value. This opinion or estimate is arrived at through a formal process that typically uses the three ''common approaches to value''. They are the Cost Approach - which is what it would cost to replace the improvements, less physical deterioration and other factors, plus the land value. There is the Sales Comparison Approach - which involves making a comparison to other similar, nearby properties which have recently sold. The Sales Comparison Approach is normally the most accurate and best indicator of value for a residential property. The third approach is the Income Approach, which is of most importance in appraising income producing properties - it involves estimating what an investor would pay based on the income produced by the property. For a more detailed description of the appraisal process click here: What is an appraisal?
What does an appraiser do? Back to top
An appraiser provides a professional, unbiased opinion of market value, to be used in making real estate decisions. Appraisers present their formal analysis in appraisal reports.
Why would a person need a home appraisal? Back to top
There are many reasons to obtain an appraisal with the most common reason being real estate and mortgage transactions. Other reasons for ordering an appraisal include:
To obtain a loan.
To lower your tax burden.
To establish the replacement cost of insurance.
To contest high property taxes.
To settle an estate.
To provide a negotiating tool when purchasing real estate.
To determine a reasonable price when selling real estate.
To protect your rights in a condemnation case.
Because a government agency such as the IRS requires it.
If you are involved in a lawsuit.
For more details on when you might need an appraisal click here: When to get an Appraisal
What is the difference between an appraisal and a home inspection? Back to top
The appraiser is not a home inspector nor does he/she do a complete home inspection. An inspection is a third-party evaluation of the accessible structure and mechanical systems of a house, from the roof to the foundation. The standard home inspector's report will include an evaluation of the condition of the home's heating system, central air conditioning system (temperature permitting), interior plumbing and electrical systems; the roof, attic, and visible insulation; walls, ceilings, floors, windows and doors; the foundation, basement, and visible structure.
What is the difference between an Appraisal and a Comparative Market Analysis (CMA)? Back to top
Simply put, the difference is night and day. The CMA relies on vague market trends. The appraisal relies on specific, verifiable comparable sales. In addition, the appraisal looks at other factors like condition, location and construction costs. A CMA delivers a ''ball park figure.'' An appraisal delivers a defensible and carefully documented opinion of value.
But the biggest difference is the person creating the report. A CMA is created by a real estate agent who may or may not have a true grasp of the market or valuation concepts. The appraisal is created by a licensed, certified professional who has made a career out of valuing properties. Further, the appraiser is an independent voice, with no vested interest in the value of a home, unlike the real estate agent, whose income is tied to the value of the home.
What does the appraisal report contain? Back to top
Each report must reflect a credible estimate of value and must identify the following:
The client and other intended users.
The intended use of the report.
The purpose of the assignment.
The type of value reported and the definition of the value reported.
The effective date of the appraiser's opinions and conclusions.
Relevant property characteristics, including location attributes, physical attributes, legal attributes, economic attributes, the real property interest valued, and Non real estate items included in the appraisal, such as personal property, including trade fixtures and intangible items.
All known: easements, restrictions, encumbrances, leases, reservations, covenants, contracts, declarations, special assessments, ordinances, and other items of a similar nature.
Division of interest, such as fractional interest, physical segment and partial holding.
The scope of work used to complete the assignment.
For a more detailed look at what goes into an appraisal report click here: Sample Appraisal Report
After completing the report, what assurance is there that the value indicated is valid? Back to top
In communicating an appraisal report, each appraiser must ensure the following:
That the information analysis utilized in the appraisal was appropriate.
That significant errors of omission or commission were not committed individually or collectively.
That appraisal services were not rendered in a careless or negligent manner.
That a credible, supportable appraisal report was communicated.
Most states require that real estate appraisers are state licensed or certified. The state licensed or certified appraiser is trained to render an unbiased opinion based upon extensive education and experience requirements. To become licensed or certified, appraisers must fulfill rigorous education and experience requirements. In addition, appraisers must abide by a strict industry code of ethics and comply with national standards of practice for real estate appraisal. The rules for developing an appraisal and reporting its results are insured by enforcement of the Uniform Standards of Professional Appraisal Practice (USPAP).
How are appraisers certified? Back to top
Regulations regarding licensing and certification of Real Estate Appraisers vary from state to state. However, licensing and certification is most often associated with many hours of coursework, tests and practical experience. Once an appraiser is licensed, he or she is required to take continuing education courses in order to keep the license current. To see the specific requirements for any state click here.
Who do appraisers work for? Back to top
Typically, appraisers are employed by lenders to estimate the value of real estate involved in a loan transaction. Appraisers also provide opinions in litigation cases, tax matters and investment decisions.
Where does an appraiser get the information used to estimate value? Back to top
Gathering data is one of the primary roles of an appraiser. Data can be divided into Specific and General. Specific data is gathered from the home itself. Location, condition, amenities, size and other specific data are gathered by the appraiser during an inspection.
General data is gathered from a number of sources. Local Multiple Listing Services (MLS) provide data on recently sold homes that might be used as comparables. Tax records and other public documents verify actual sales prices in a market. Flood zone data is gathered from FEMA data outlets, such as a la mode's InterFlood product. And most importantly, the appraiser gathers general data from his or her past experience in creating appraisals for other properties in the same market.
Why do I need a professional appraisal? Back to top
Anytime the value of your home or other real property is being used to make a significant financial decision, an appraisal helps. If you're selling your home, an appraisal helps you set the most appropriate value. If you're buying, it makes sure you don't overpay. If you're engaged in an estate settlement or divorce, it ensures that property is divided fairly. A home is often the single, largest financial asset anybody owns. Knowing its true value means you can the right financial decisions.
What exactly is PMI and how can I get rid of it? Back to top
PMI stands for Private Mortgage Insurance. It insures a lender against loss on homes purchased with a down-payment of less than 20%. Once equity in the home reaches 20% you can eliminate the PMI and start saving immediately. For a detailed discussion of PMI and how to get rid of it click here: What is PMI and how to get rid of it
How do I get ready for the appraiser? Back to top
The first step in most appraisals is the home inspection. During this process, the appraiser will come to your home and measure it, determine the layout of the rooms inside, confirm all aspects of the home's general condition, and take several photos of your house for inclusion in the report. The best thing you can do to help is make sure the appraiser has easy access to the exterior of the house. Trim any bushes and move any items that would make it difficult to measure the structure. On the inside, make sure that the appraiser can easily access items like furnaces and water heaters.
The following Items, if available, will help your appraiser to provide a more accurate appraisal in a shorter period of time:
A survey of the house and property.
A deed or title report showing the legal description.
A recent tax bill.
A list of personal property to be sold with the house if applicable.
A copy of the original plans.
What is ''Market Value?'' Back to top
Market value or fair market value is the most probable price that a property should bring (will sell for) in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: (1) buyer and seller are typically motivated; (2) both parties are well informed or well advised; (3) a reasonable time is allowed for exposure to the open market; (4) payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and (5) the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.
Who Actually Owns the Appraisal Report? Back to top
In most real estate transactions, the appraisal is ordered by the lender. While the home buyer pays for the report as part of the closing costs, the lender retains the right to use the report or any information contained within. The home buyer is entitled to a copy of the report - it's usually included with all of the other closing documents - but is not entitled to use the report for any other purpose without permission from the lender.
The exception to this rule is when a home owner engages an appraiser directly. In these cases, the appraiser may stipulate how the appraisal can be used; for PMI removal, or estate planning or tax challenges, for example. If not stipulated otherwise, the home owner can use the appraisal for any purpose.
Which home renovations add the most to the price? Back to top
The answer to this is different depending upon the location of the home. Different markets value amenities differently. Adding a central air conditioner in Houston, Texas may add significant value, while putting one in a home located in Buffalo, New York might not have much impact.
As a rule, the most value returned from renovating a home comes in the kitchen. According to one national survey, kitchen remodels returned an average of 88% of the investment. In other words, a $10,000 kitchen remodeling project would add approximately $8,800 to the value of the home. Bathrooms were second, returning 85%.
How To Prepare For Your Appraisal
How to Prepare for an Appraisal
For homeowners, a real estate appraisal is the linchpin to buying or selling their home. It allows the property transactions to occur among the buyer, seller, real estate agent and mortgage lender.
Before an Appraiser arrives, there are a few things you should know. By law, an appraiser must be state licensed to perform appraisals prepared for federally related transactions. Also by law, you are entitled to receive a copy of the completed appraisal report from your lender.
To facilitate the appraisal process, it's beneficial to have these documents ready for the appraiser:
- A plot plan or survey of the house and land (if readily available)
- Information on the latest purchase of the property in the last three years
- Written property agreements, such as a maintenance agreement for a shared driveway
- List of personal property to be sold with the home
- Title policy that describes encroachments or easements
- Most recent real estate tax bill and or legal description of the property
- Home inspection reports, or other recent reports for termites, EIFS (synthetic stucco) wall systems, septic systems and wells
- Brag sheet that lists major home improvements and upgrades, the date of their installation and their cost (for example, the addition of central air conditioning or roof repairs) and permit confirmation (if available)
- A copy of the current listing agreement and broker's data sheet and Purchase Agreement if a sale is "pending".
- Information on "Homeowners Associations" or condominium covenants and fees.
- A list of "Proposed" improvements if the property is to be appraised "As Complete".
Once your appraiser has arrived, you do not need to accompany him or her along on the entire site inspection, but you should be available to answer questions about your property and be willing to point out any home improvements.
Here are some other suggestions:
- Accessibility: Make sure that all areas of the home are accessible, especially to the attic and crawl space
- Housekeeping: Appraisers see hundreds of homes a year and will look past most clutter, but they're human beings too! A good impression can translate into a higher home value
- Maintenance: Repair minor things like leaky faucets, missing door handles and trim
- FHA/VA Inspection Items: If your borrower is applying for an FHA/VA loan, be sure to ask your appraiser if there are specific things that should be done before they come. Some items they may recommend might be: Install smoke detectors on all levels (especially near bedrooms); install handrails on all stairways; remove peeling paint and repaint the effected area; provide inspection access to the attic and crawl
Appraisal Myths
Some Myths and Realities About
Real Estate Appraisals and Appraisers
Myth: Assessed value should equate to market value.
Reality: While most states support the concept that assessed value approximate estimated market value, this often is not the case. Examples include when interior remodeling has occurred and the assessor is unaware of the improvements, or when properties in the vicinity have not been reassessed for an extended period.
Myth: The appraised value of a property will vary, depending upon whether the appraisal is conducted for the buyer or the seller.
Reality: The appraiser has no vested interest in the outcome of the appraisal and should render services with independence, objectivity and impartiality - no matter for whom the appraisal is conducted.
Myth: Market value should approximate replacement cost.
Reality: Market value is based on what a willing buyer likely would pay a willing seller for a particular property, with neither being under pressure to buy or sell. Replacement cost is the dollar amount required to reconstruct a property in-kind.
Myth: Appraisers use a formula, such as a specific price per square foot, to figure out the value of a home.
Reality: Appraisers make a detailed analysis of all factors pertaining to the value of a home including its location, condition, size, proximity to facilities and recent sale prices of comparable properties.
Myth: In a robust economy - when the sales prices of homes in a given area are reported to be rising by a particular percentage - the value of individual properties in the area can be expected to appreciate by that same percentage.
Reality: Value appreciation of a specific property must be determined on an individualized basis, factoring in data on comparable properties and other relevant considerations. This is true in good times as well as bad.
Myth: You generally can tell what a property is worth simply by looking at the outside.
Reality: Property value is determined by a number of factors, including location, condition, improvements, amenities, and market trends.
Myth: Because consumers pay for appraisals when applying for loans to purchase or refinance real estate, they own their appraisal.
Reality: The appraisal is, in fact, legally owned by the lender - unless the lender "releases its interest" in the document. However, consumers must be given a copy of the appraisal report, upon written request, under the Equal Credit Opportunity Act.
Myth: Consumers need not be concerned with what is in the appraisal document so long as it satisfies the needs of their lending institution.
Reality: Only if consumers read a copy of their appraisal can they double-check its accuracy and question the result. Also, it makes a valuable record for future reference, containing useful and often-revealing information - including the legal and physical description of the property, square footage measurements, list of comparable properties in the neighborhood, neighborhood description and a narrative of current real-estate activity and/or market trends in the vicinity.
Myth: Appraisers are hired only to estimate real estate property values in property sales involving mortgage-lending transactions.
Reality: Depending upon their qualifications and designations, appraisers can and do provide a variety of services, including advice for estate planning, dispute resolution, zoning and tax assessment review and cost/benefit analysis.
Myth: An Appraisal is the same as a home inspection.
Reality: An Appraisal does not serve the same purpose as an inspection. The Appraiser forms an opinion of value in the Appraisal process and resulting report. A home inspector determines the condition of the home and its major components and reports these findings.
About PMI
What is PMI and how to get rid of it
Real estate lenders are a funny lot. It seems they're happy to lend anybody money. Assuming a half-way decent credit rating, any potential home buyer can secure a loan for a house. Why? Because these transactions are secured by a very valuable asset: the home itself. If a borrower defaults on a loan, the risk for the lender is often only the difference between the value of the home and the amount outstanding on the loan, less the amount it costs them to foreclose and resell the property.
For this reason, lenders are very wary of lending more than a certain percentage of a home's value. Traditionally, this has been 80 percent. The cushion this provides the lender helps ensure that their losses from loan defaults are kept to a minimum.
In recent years, however, it has become increasingly more common to see home buyers using down payments of 10, 5 or even 0 percent. Naturally, loaning this much presents the lenders with a lot more risk. To offset this risk, these transactions often require Private Mortgage Insurance or PMI. This supplemental policy protects the lender in case a borrower defaults on the loan, and the value of the house is lower than the loan balance.
PMI has been a large money-maker for the mortgage lenders. The amount of the insurance - often $40-$50 per month for a $100,000 house - is commonly rolled into the mortgage payment. Given the size of the overall payment, this additional fee is often overlooked. Homeowners continue to pay the PMI even after their loan balance has dropped below the original 80 percent threshold. This occurs naturally, of course, as the home owner pays down the principal on the loan. On a typical 30-year loan, however, it can take many years to reach that point.
Until recently lenders were under no obligation to tell home owners when they had reached a point where the PMI can be dropped. That all changed in 1999, when the Homeowners Protection Act took effect. In most cases, this law now obligates lenders to terminate the PMI when the principal balance of the loan reaches 78 percent of the original loan amount. Savvy homeowners can get off the hook a little earlier. The law stipulates that, upon request of the home owner, the PMI must be dropped when the principal amount reaches only 80 percent!
It is important to note that this law only applies to home loans - whether first time or refinances - that closed after July, 1999. Also certain other conditions must be met, such as being current on the loan payments. Buyers that purchased before July 1999 can also have their PMI removed, but they must initiate the process and though the lender is under no obligation to do so, most will.
Of course, there is another way that home owner's equity can reach beyond the 80/20 percent ratio. Many areas of the United States have seen significant gains in the value of real estate over the past decade. In fact, certain areas have seen appreciation levels of 100 percent or more. Even those people living in areas with more modest gains may find that the value of their property has quickly grown to the point where the amount of principal they owe on their loan is less than 80 percent of the home's current value. Again, in these cases, the lenders are under no legal obligation to remove the PMI. In most cases, however, as long as the home owner has been prompt on their loan payments and don't represent an exceptional risk, the lenders will agree to remove the extra fees.
The hardest thing for most home owners to know is just when does their home equity rise above this magical 20 percent point? A certified, licensed real estate appraiser can certainly help. It is an appraiser's job to know the market dynamics of their area. They know when property values have risen - or declined. Many appraisers offer specific services to help customers find the value of their homes and remove PMI payments. Faced with this data, the mortgage company will most often eliminate the PMI with little trouble. The savings from dropping the PMI pays for the appraisal in a matter of months. At which time, the home owner can enjoy the savings from that point on.
For more information on PMI and the Homeowners Protection Act, try one of these links:
Cancellation of Private Mortgage Insurance: Federal Law May Save You Hundreds of Dollars Each Year
Private Mortgage Insurance (PMI): Law Requires Lenders to Cancel PMI
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