With home prices dare I say a little frothy these days, low appraisals are becoming a concern again for home buyers.
It wasn’t uncommon for appraisals to come in low in the early 2000s when home prices were flying ever higher.
This happened towards the end of the cycle when banks and lenders could no longer justify slapping an astronomical valuation onto a property.
As a result, lots of mortgage deals fell apart based on the collateral alone and the financing spigot essentially got shut off.
While we fortunately aren’t back to those days, here’s what you need to know if your appraisal happens to come in low.
Why an Appraisal Is Important for a Home Purchase
One of the key qualifying criteria for getting approved for a home loan is the collateral value of the property.
Aside from your own borrower characteristics, such as your credit score and DTI ratio, the property also has to be valued by an independent party.
After all, you might be an excellent borrower and a low default risk, but the bank will still want to know the property itself is worth taking a risk on.
Lenders also need to know how leveraged you’ll be, and simply that there’s an independent assessment of the value beyond the buyer and seller to ensure there’s no funny business.
This is the job of a third-party home appraiser, who will be hired early on in loan process to determine the property’s present value.
The appraiser has the ability to value the property above the contract sales price, at the contract price, or below.
Often, it tends to come in “at value,” meaning if the purchase price was $500,000, it was supported and all is well.
Lenders Use the Lower of the Purchase Price or Current Appraised Value
Note that for home purchase transactions, lenders use the lower of the purchase price and the current appraised value (Fannie Mae source).
So if you agreed to a $500,000 purchase, and it comes in at $475,000, the latter number will be used for all mortgage qualifying purposes.
This will apply to your loan-to-value ratio (LTV), your loan-level pricing adjustments (LLPAs), and your required down payment.
It will also determine if you need to pay mortgage insurance or not, depending on the LTV using the appraised value.
So it’s very important that the appraisal does not come in below the purchase price.
This is especially true if you don’t have additional funds for a larger down payment.
Or if your DTI ratio is already pretty close to the limit, and a higher rate or a loan amount could push you over.
Why Do Appraisals Come in Low?
There are times when the appraised value falls short, due to lower-valued comparable sales not supporting the price inputted on the loan application.
The reasons an appraisal might come in below value could be due to a declining market.
For example, suppose prices are now falling in a given metro, and the subject property is not immune.
The appraiser may note that prices are falling in said market and assign a lower price as a result.
It could also be for the opposite reason. You could have a very hot market, where there are lots of bidding wars.
And if the winning bid is above the value that the market supports, the appraisal could come in low.
It’s also possible to get low appraisal in areas where there aren’t many recent sales comps.
Or simply if you have an appraiser that uses “the wrong comps” or happens to be very conservative.
Ultimately, there are many ways to wind up with a low appraisal, but fortunately there are solutions to overcome it.
What to Do If the Appraisal Comes in Low
While appraisals often come in at the purchase price, there are times when they don’t. Fortunately, there are ways to deal with it.
One solution is to try to get a second opinion or challenge the facts with a reconsideration of value.
Of course, this might not be the best use of your time or the most promising route for success.
Time will likely be of the essence, so chances are a renegotiation of the purchase price or a loan restructuring might be a better, more realistic option.
You’ve basically got a sales price approach, or a loan amount approach.
And this will be driven by how competitive your market is, along with the seller’s openness to negotiate.
For example, you could ask the seller to lower the purchase price to the appraised value.
Then your loan amount would be sufficient based on the original criteria such as the LTV.
If they’re unwilling to budge, you might have to bring in more money to make the LTV work.
Let’s look at an example to illustrate these two scenarios.
You Could Increase Your Down Payment
| Seller Won’t Budge | Purchase Price ($500k) | Appraised Value ($475k) |
| Loan Amount | $400,000 | $380,000 |
| Down Payment | $100,000 | $120,000 |
We’ll pretend the property purchase price was $500,000. And you were coming in with a 20% down payment.
Now imagine the property gets appraised for just $475,000, which is $25,000 below the contract price.
Your LTV was originally 80%, but as a result of the lower value, it is now a higher 84%.
This means your loan is now subject to mortgage insurance. And higher LLPAs, which will likely result in a higher mortgage rate.
What you can do here is bring in more money for the down payment if you have it.
In this example, it would require an additional $20,000 to get the LTV back to 80%.
You would be borrowing $380,000 instead of $400,000, which does mean it’s a smaller loan amount. However, you’d be putting down $120,000 instead of $100,000.
Or Ask the Seller to Lower the Purchase Price
| Seller lowers price | Old Purchase Price ($500k) | New Purchase Price ($475k) |
| Loan Amount | $400,000 | $380,000 |
| Down Payment | $100,000 | $95,000 |
An alternative would be for the seller to lower their price or potentially meet you somewhere in the middle.
So if they agreed to lower the price to $475,000, you would only need a down payment of $95,000.
This would give you a new loan amount of $380,000 while staying at 80% LTV.
As such, you wouldn’t have to worry about a potentially higher mortgage rate or mortgage insurance.
But chances are the seller might hold firm or only meet you somewhere in the middle.
So you would need to be prepared for all the different options. If you couldn’t agree, the deal might fall through.
This illustrates the importance of having a financing contingency, to ensure your earnest money is protected in the event of an appraisal issue.
What About a Low Appraisal on a Refinance?
It’s also possible to get a low appraisal on a refinance application, assuming you already own the property.
They even say appraisers are more conservative on values when it comes to refis vs. purchases.
How it affects you will depend on the type of refinance in question.
If it’s a rate and term refinance, you might have to bring some money to the closing table to make it work.
Or possibly be subject to greater costs associated with a higher LTV, which may affect the LLPAs.
There is also such a thing as a cash-in refinance, where you pay down the outstanding loan balance to either quality or lower your LTV.
In this case of a cash out refinance, it might just mean lower proceeds at closing. For example, if you were expecting to receive $75,000 in cash, you might only be eligible for say $60,000.
But you can still close the deal. Or as noted, you can adjust the LTV higher if permitted if you want/need the full amount of cash.
For refinances, the appraised value is used since there isn’t a purchase price to go on. However, you do input an estimated value on the loan application.
Unlike with a purchase, if the appraised value happens to come in higher on a refinance, you might be able to take advantage of a larger loan amount or lower LTV.
If the appraisal comes in higher on a purchase, it might just mean you got a deal and can give yourself a pat on the back.
