What is the point of a home appraisal?

[disneysteve]

I've seen a few posts lately in other forums about folks who are in the process of buying a house and run into trouble because the appraisal came back at less than the purchase price. What exactly is the point of the appraisal? If I'm selling a house and asking 300K and you're willing to buy the house for 300K, why does it matter if the appraisal says the house is only worth 280K? Is it an insurance issue? Isn't the house worth whatever someone is willing to pay for it?

[HundredK]

I've seen a few posts lately in other forums about folks who are in the process of buying a house and run into trouble because the appraisal came back at less than the purchase price. What exactly is the point of the appraisal? If I'm selling a house and asking 300K and you're willing to buy the house for 300K, why does it matter if the appraisal says the house is only worth 280K? Is it an insurance issue? Isn't the house worth whatever someone is willing to pay for it?

My guess is that the bank doesn't want to lend you more than the appraised amount, or has some calculation as to how much you can borrow based on the appraisal. I don't know for sure, but that's my first thought.

[kork13]

HundredK is correct. The appraisal is purely there to make the bank feel comfortable about loaning you a quarter-mil or more on a house. If an appraisal comes in low, and you have a small/zero downpayment, the bank will only loan you up to the appraised amount (or often less).

By contrast, when we purchased our most recent home for cash, we didn't even get an appraisal. It wasn't of any use, we knew what we were willing to pay for it, and it wasn't anyone else's business how much it is or isn't worth. One of the many ways that buying for cash was shockingly cheap (as it relates to transaction costs, at least).

[disneysteve]

So the appraisal determines how much the lender will lend you. Can you still pay the asking price as long as you can put up the difference? Or do buyers then use the appraisal as a negotiating tool to talk down the price?

[TexasHusker]

So the appraisal determines how much the lender will lend you. Can you still pay the asking price as long as you can put up the difference? Or do buyers then use the appraisal as a negotiating tool to talk down the price?

yes and yes

[TexasHusker]

I've seen a few posts lately in other forums about folks who are in the process of buying a house and run into trouble because the appraisal came back at less than the purchase price. What exactly is the point of the appraisal? If I'm selling a house and asking 300K and you're willing to buy the house for 300K, why does it matter if the appraisal says the house is only worth 280K? Is it an insurance issue? Isn't the house worth whatever someone is willing to pay for it?

It's complicated. By law, appraisers must use comparable sales ("comps") to support their appraisal. The agreed-upon price of the subject property doesn't count. The appraisal doesn't matter if you are a cash buyer. I bought two properties in TN recently for cash and I don't care what an appraiser says they are worth. In fact I didn't order an appraisal on either. But if I am obtaining a mortgage to buy a home, the lender is going to require an appraisal to protect themselves, per Fannie Mae and Freddie Mac guidelines. Those guidelines specify how much a lender can lend, and it's all tied to a bona fide appraisal. A lender doesn't want to be on the hook for 80 or 90 percent of an inflated home value if the mortgagee defaults.

Of course, this isn't an exact science, and there are abuses all over the country right now with appraisals that will end up bringing a great deal of pain.

[ua_guy]

I was shocked recently by the cost of a lender-required appraisal. About $1,000 here in this hot market.

It used to be appraisers driving by a house and snapping a few pictures as they flew by, writing for whatever the bank whispered in their ear. Now it's more detailed. Our appraiser actually walked the house, the property, took measurements, and asked detailed questions about finishes and upgrades. Photos and descriptions, room by room. He had to provide extensive documentation supporting the offer price, which was over asking.

[TexasHusker]

Many deals are falling through throughout the country because folks can’t get appraisals, surveys, and inspections done, for any price.

[disneysteve]

Many deals are falling through throughout the country because folks can’t get appraisals, surveys, and inspections done, for any price.

Why is that? I thought a lot of the reason for the whole seller’s market is because there is so little inventory. Wouldn’t that mean the folks who do that stuff aren’t as busy as usual?

[TexasHusker]

Why is that? I thought a lot of the reason for the whole seller’s market is because there is so little inventory. Wouldn’t that mean the folks who do that stuff aren’t as busy as usual?

While it is a seller’s market and there is little inventory, the transactions volume is massive. Houses are often under contract before they are even listed.

As a side note, there exists a market imbalance due to lots of free money and artificially low interest rates. Thus, there is unprecedented inflation in RE. There won’t be a soft landing. When this thing goes pop, it will make the financial crisis seem like a picnic. You have people all over the country paying far too much for homes.

[Drake3287]

So the appraisal determines how much the lender will lend you. Can you still pay the asking price as long as you can put up the difference? Or do buyers then use the appraisal as a negotiating tool to talk down the price?

Not only yes, here in many area's of California it's the new norm. With most home's now getting dozens of offers overnight for more than the asking price it's now a bidding war. Many of these people are needing to come up with more cash to fill the difference between the appraised value and the sales price. For MANY of these people, when the market goes back down there'll be under water, just like back in 2008 or so.

My son's in this exact situation. He's looking for a house in the mid $400,000 range but everything's getting bid up to $500,000 or more. Unfortunately he might miss these record low interest rates but at least he's not paying $550,000 for a $450,000 house. Terrible time for many of these buyers right now.

[TexasHusker]

One of the vacation rentals I just purchased in January for $230K...I decided I would test the water to see what it would sell for now. I put it on Zillow for $342K, and I could have sold it once a day easily, with one guy offering $355K. That’s nuts.

https://www.zillow.com/homedetails/1...81459303_zpid/

[disneysteve]

One of the vacation rentals I just purchased in January for $230K...I decided I would test the water to see what it would sell for now. I put it on Zillow for $342K, and I could have sold it once a day easily, with one guy offering $355K. That’s nuts.

https://www.zillow.com/homedetails/1...81459303_zpid/

That is crazy. What a beautiful home by the way.

Would you consider selling it? I guess the question is how long do you need to own it for it to generate 120K in income? How many years worth of rentals is that?

[TexasHusker]

That is crazy. What a beautiful home by the way.

Would you consider selling it? I guess the question is how long do you need to own it for it to generate 120K in income? How many years worth of rentals is that?

Good question. My gain was going to be $112,000. But since I’ve only held it for 3-4 months, that gain would be taxed as ordinary income. That’s around a $40,000 tax on the gain, leaving me with $72,000.

Well, I have $30,000 in bookings for the next 6 months that I would be walking away from, so now I’m down to $42,000.

Even after all expenses are factored in, this is a bare minimum of a $2000 a month income to me from now on. So trading that income for a quick $72,000 didn’t seem to make any sense whatsoever.

But it was tempting to do it, just so I could say that I made $112K in 3 months. Emotions and pride can kill your investment plan. I think I made the correct choice. Time will tell.

[disneysteve]

Good question. My gain was going to be $112,000. But since I’ve only held it for 3-4 months, that gain would be taxed as ordinary income. That’s around a $40,000 tax on the gain, leaving me with $72,000.

Even after all expenses are factored in, this is a bare minimum of a $2000 a month income to me from now on. So trading that income for a quick $72,000 didn’t seem to make any sense whatsoever.

But it was tempting to do it

How is the rental income taxed? Is that also treated as ordinary income? If so, it's not really 72K vs 2K/month; it's 112K vs 2K/month. So you'd have to have it rented out for nearly 5 years to make that money. There are also some risks with the rentals that you don't have with the quick flip: vacancy, damage, etc. (although you may already factor that in to your expenses).

Definitely tempting to make that kind of money that quickly, but then you're left with 350K that you need to do something else with.