When you buy or refinance a house, and you take a loan out for that home, you are looked at from a few perspectives. As mentioned in the previous few blogs, there are four items a mortgage underwriter looks at — the four C’s — capacity, credit, cash and collateral. Though you may be credit-worthy, have enough cash (or assets) and have the capacity to qualify (sufficient income), the collateral, or the house you’re purchasing/refinancing, may not be up to snuff. Let’s look at what is important to the underwriter for this final blog in the series.
It would only make sense that the house you’re taking a loan against would be of importance to the mortgage lender. Like with a car, when you do a trade-in at the dealership, they want to make sure it works, isn’t too old and probably a few more attributes that I am not privy too since I am not in that industry! But they want to inspect it and make sure it’s worth what they give you for a trade or a loan. Same thing with the house you want to purchase or your current home you want to refinance. We want to make sure we are making a good investment.
I want to first start with something that is not required on the part of the lender to determine this – the inspection. This is something you choose to do even before the lender starts their process of determining acceptability of the home. The inspection is your way to determine if the house is acceptable to YOU. And of course, if you’re going to live there and make the investment of money and payments, you definitely want to make sure it’s worth it. You pay the inspector directly and costs can average from $350-$550. They will look at the structure, necessary maintenance and point out the good and the bad. If you made your offer contingent on an inspection, this will help you determine if you plan to move forward or not.
The lender, on the other hand, will send an appraiser out to the property. This also costs you on average $450 – $550 (possibly more depending on the property type). The cost for this is typically lumped into the closing costs you pay at closing, but some lenders will collect this prior to ordering. The appraiser is chosen randomly from a list as to avoid any influencing from the lender.
The appraiser’s main goal is to confirm value is there by giving their opinion of value – meaning, for a purchase, making sure the house is valued at what you paid for it. In the appraisal they give supporting detail on how they arrived at this number using similar properties – meaning same style, approximate size, similar number bedrooms/bathrooms and similar amenities, to mention a few characteristics.
The appraiser will research homes that have sold and closed in the last 12 months to use as comparable properties. They need to use at least three closed sales and need to look at one inferior property and one superior property to the one you’re purchasing or refinancing. This way, there is a range for comparison. The more recent those closed sales, the better indicator of current value.
They will provide a description of the property and assess condition and marketability of the home and detail any other property issues, if any. It could be that the home has deferred maintenance and the roof shingles are peeling. This is a cause for concern and affects the condition. The appraiser may require the roof to be repaired prior to closing.
Or maybe the house is on a very busy street or directly under the flight path of the airport – these can affect marketability. And you know the adage … “location, location, location”… This is so true with appraisals too. Maybe it’s overlooking a bluff with views or the local waste site. These can affect the value of the home.
Similar homes used for comparable properties should be in the same general area as the home you’re financing. If you’re buying in the city, the homes should be within blocks of each other and easy enough to find homes similar to the one you’re financing. On the flip side, a rural property will be harder to find comparable sales since the houses themselves could be quite a distance apart, plus there won’t be as many. The appraiser may have to extend their search for closed properties out further in distance and may have to look further back in time to find those closed properties.
The appraiser is the eyes for the lender. They are reporting on what they see. Pictures are provided so the underwriter can review the home to see if there are any blatant issues and that the properties used for comparison are really similar to the subject property (home you’re financing). Appraisals are objective, so different appraisers could value a home differently depending on their training or data they find to support the value.
Financial adjustments are made to the sale price of the comparable homes to make them more similar to the home you’re purchasing. If the home you want to finance has a 3-car garage and one perfect comparable property (size, style, # bedrooms, etc.) has a 2-car garage, then that one would be adjusted down since a 3-car garage would be more valuable than two.
Also important to know is that mortgage lenders will lend on the LESSER of the appraised value or the purchase price. As an example, if you purchase a home for $100,000 with 5% down, that means you are financing $95,000. Let’s say the appraisal comes in at $97,000. If nothing can be renegotiated with the seller, then the lender will only lend $92,150, which is 5% down off the VALUE of $97,000 since that is the lesser figure. As the buyer, you would then need to come up with the difference between the value ($97,000) and the price you paid ($100,000). This would go back to the third “C,” cash, and confirming you would have the means/resources to do this.
Biggest thing to understand here is that this fourth “C” is not about you – it’s about the home. There isn’t anything you can do about the appraisal. The hope is it will come in with the necessary value and no additional work requirements. But if it doesn’t, your lender will work with you, and the possible real estate agents involved, to find a solution, if one is available, to make your financing work. We all have the same goal – helping you finance your home. We want nothing more than for you to have your house to call “home!”