When buying a home, mortgage financing requirements are subject to lender approval, which is based on certain conditions including an appraisal of the property. The appraisal is conducted by a licensed, professional real estate appraiser who provides an evaluation of the home’s fair market value using factors such as size, location, condition and recent sales of similar homes in the area. Lenders use the property’s valuation to measure the amount for which buyers qualify relative to the market value of the property they’re financing. This is known as a loan-to-value ratio or LTV.
Ideally, the appraised or fair market value of the property should be in sync with the agreed-to purchase price. Recently, however, there has been a noticeable disconnect. Appraisals are coming in lower than the selling price due in large part to bidding wars, which are becoming commonplace, and disproportionately reflecting a home’s true value. In order to seal the deal, buyers are paying hundreds of thousands of dollars over asking, meaning the probability of the appraised value aligning with the sale price is unlikely.
If the appraisal falls short, buyers will either need to raise their offer or sellers will need to lower their price. And with the latter currently sitting high atop the wild ride of real estate, the former course of action appears more realistic. This means buyers will need to increase their down payment, which they may not have, or require a larger loan to make up the difference, which can prove problematic if they don’t qualify and are forced to find another approach to bridge the gap.
Competitive marketplace often equals added risk
Since the onset of COVID-19, an inventory shortage has led to fierce competition among homebuyers forcing many, in addition to paying far more than asking, to waive all conditions in order to increase their chances of securing the winning bid. Conditions on an offer to purchase are designed to protect buyers’ interests, and financing conditions in particular are critical as they allow buyers the option to walk away should they be unable to secure the required loan and complete the purchase.
With significant gaps between appraisals and what buyers are willing to pay, the repercussions of unconditional offers could be devastating. If the deal falls through, buyers will not only lose their deposit, but they could also be sued for damages and breach of contract by the seller.
If you’re in the market to buy a home, start by determining how much you can comfortably afford to spend by working with your mortgage agent to get preapproved, evaluate how much a home is worth to you and make sure you’re not putting yourself at risk by over-bidding just to win the deal. The prospect of losing out may be disheartening, but it’s important to know your limit and ensure you have enough latitude if the appraisal and sale price are out of whack.
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