Appraisals are a critical part of any real estate deal, but especially when it comes to buying and selling a house, or other residential property. That is so because the appraisal sets the value of the property, which can affect whether or not the deal closes.

Because appraisals play such a critical role, you should know some things about how the appraisal process works, when you're required to get an appraisal, who will prepare the appraisal.

How the Appraisal Process Works

As a seller, an appraisal provides you with a value for your home, and can be a starting point in setting the price for your home when you list it for sale. So, it's not uncommon for a seller to have his or her real estate appraised even before or shortly after he or she contacts a real estate agent or broker. Of course, when the seller does this, it falls on him or her to pay for the appraisal.

A buyer has slightly different reasons for getting an appraisal. The buyer needs to know if the seller is asking a reasonable price for home. Obviously, a buyer is less likely to buy house that's listed for $ 175,000 when it appraises for only $ 150,000. There's no "bargain" there.

More important, however, is when the buyer will be financing the purchase, that is, getting a mortgage from a bank or other lender, like a mortgage company. As a general rule, the appraised value with dictate how much the bank will lend the buyer. Again, a bank typically won't lend a buyer more than the property's appraised value, and will probably lend somewhat less than the appraised value. That's so because if the buyer defaults or fails to make his mortgage payments, the bank will foreclose the mortgage, sell the house, and apply the proceeds to the mortgage balance, along with paying foreclosure costs. So, the bank needs to be sure that the home will sell for at least as much as the amount of the mortgage and the costs of foreclosure.

Along these same lines, if a buyer wants to finance a home purchase with a loan from the Federal Housing Administration (FHA), an appraisal is required. As with any lender, the appraisal is used to set the home's market value for purposes of determining whether it qualifies for a FHA-backed loan and the maximum amount of that loan.

Appraisal Methods

Usually, a home will be appraised in one of two ways:

  • Sales comparisons, which is where the appraiser compares the target home (the one being bought or sold) to other homes in the area or neighborhood that have sold recently. Those homes are called "comparables," or "comps," and the appraiser will usually look at least three homes to get a good comparison upon which to base the value of the target home.
  • Replacement costs, which is where the appraiser figures out how much it would cost to rebuild the home, such as if it was destroyed by a fire, or to "copy" the home and build it new. This type of appraisal is commonly used when the home is a newly built one because the costs are usually known by the seller (or builder) or are easily determined.

In addition to giving an appraised value and listing comps, an appraisal report typically will list things like any visible defects, such as a cracked foundation. Also, if the buyer is seeking FHA financing, the appraiser will list things that might affect the livability of that property in terms of the buyer's basic needs, health, and safety of the buyer, such as the lack of handrails on steps and the existence of lead paint.

Choosing an Appraiser and Appraisal Costs

Real estate appraisers have to undergo training and education, and they typically have to be licensed by the state in which they work. A good place to start looking for an appraiser is the Appraisal Foundation, which is a private non-profit educational organization that has been authorized by the U.S. Congress as the source of appraisal standards and appraiser qualifications. Lenders and real estate agents will often refer clients to appraisers as well.

The cost of an appraisal varies by appraiser, location, and the type and value of the property. For example, an appraisal for a an upscale home will be more than one for a home in a middle-class neighborhood, and one done in New York City will be more than one done in a rural area. In general, though, one can be expected to pay anywhere from $ 200 to $ 600 for a home appraisal.

Questions for Your Attorney

  • What can I do if I don't agree with the value that my appraiser came up with?
  • Can I require the seller to get and pay for an appraisal before I sign a sales contract?
  • I need a FHA loan, but the appraisal is much lower than the seller's price? Can I make up the difference in cash, or will FHA just deny my application outright?