Even though everybody said it’s impossible to get your offer accepted, you still did. You succeeded. You won! Congratulations! The contract is now signed and ratified, and your earnest money is in. Everything’s all good… until you get that appraisal number. It turns out you’re one of those people who got an appraisal lower than the purchase price. Now, that’s a problem for a lot of reasons.
If that sounds like some horror story you’ve only read about the news so far, or you’ve had a friend or a family member experience it, but you personally haven’t yet, I can assure you it’s not very fun. I’ve actually been the recipient of this on an investment property one time, but that’s not what we’re talking about. Today, we’re going to talk about you, the East Bay real estate market, and things you need to understand about this whole appraisal process.
An overview of the appraisal process
In the heat of competition, people often increase and increase their offers to get a better chance at winning. They would go leapfrogging one another as much as $30,000, $50,000, or even $100,000 to try and win. However, that’s only really good and gratifying until you have to get the opinion of an appraiser.
An Appraiser’s Job
Anytime you’re getting a loan, the lender will make you pay for an appraiser. An appraiser is an independently licensed third party individual who is not a party to the transaction. This means they have no financial interest in the outcome of that deal. They don’t get paid a commission or fees of any kind out of the contract. They’re simply going to be paid to do their job. And as an independent, non-biased person, what they’re supposed to do is to find a way to support the purchase price of your future home.
Once you get your offer accepted, your lender will order the appraisal. They’ll put it out to their pool of appraisers. Then, someone from that pool will raise their hand and say, “I’ll take that and will do it for a certain fee.” That person then gets the contract and sees how much competition there was on the house. They would go physically to the house, measure it, and look at the upgrades, view, neighborhood, etc. They would look at any additions or defects or what have you, and then make notes, take pictures, etc.
Next, they go home, and they look for comparable sales. Specifically, what they are looking for are other houses in the neighborhoods that we call comps, or “comparables”, as you probably know by now, to support the value you’re going to pay. Generally speaking, they’re really trying to look at a price per square foot in your neighborhood, which is really important to know.
There are two possible appraisal outcomes.
Appraisers do all their computation and create this big, long PDF and say, “Here’s what we can support based on all of these factors with these houses that sold at this price and that price. With all the additions or subtractions, we came out with this number, and congratulations! We can support your purchase price.”
Now, with the seller’s market that we’re in today, and with competition at an all-time high, what happens is purchase prices get pushed over the comps almost every single time. Eventually, the appraiser simply doesn’t have comparable homes to look at to validate the purchase price you’re getting at with your contract. And all of a sudden, you have a very sticky situation on your hands. Let’s talk about the ramifications of that.
Here's where your appraisal contingency comes in.
Suppose you held on to your appraisal contingency. In that case, you can negotiate based on whatever comes back from that appraiser.
However, let’s suppose you didn’t.
This is actually the case in most transactions in the East Bay. Homebuyers here often waive their contingencies to make their offers more attractive. In this case, you, as the buyer, are then contractually obligated to perform at a specific price in a certain amount of days to that seller. One more thing to think about? Because you’ve gotten this low appraisal, the bank will now only lend you money based on the appraised value and not on the price you wrote.
At that moment, most buyers will only really have one option: to bring in enough cash to make up the difference between the appraisal value that the appraiser came up with and the purchase price that you have in the contract.
What can you do to avoid getting an appraisal lower than your purchase price?
Other than bringing a bunch of money into the transaction, there are still a few other things you can do before writing your offer to avoid this situation.
1. Know the neighborhood you’re bidding on. Look at the comps very, very closely.
First, you need to know the neighborhood you’re bidding on. It would help if you looked at your comps very closely before you remove an appraisal contingency. In addition, you also really need to look at the price per square foot. Then, it would also help if you look at the nuances of those houses versus the one you’re bidding on. You have to ask yourself questions like, “Does this one have a basement, and that one doesn’t?”, “Are you looking at a house with a big view and one that doesn’t have it?” All of those factors come into play.
If you can find yourself in an appropriate range with the comps of your price per square foot, you probably have a pretty good chance of appraising.
2. Know your cash position. Know how much cash you can bring to the closing table.
Additionally, know your cash position. I wouldn’t even say this is second, as this is equally as important as looking at the comps.
Now, what this means is how much cash you have available in the event the appraiser has a bad day and ends up giving you a low number. If that happens, how much cash realistically would you be willing to come out of your pocket to complete this contract? How much are you seriously ready to bring to that closing table? You need to really think about these things. After all, there is a possibility that you’ll really need to bring in cash to not default on the contract and as a result, have the seller go after your deposit.
3. Get to know who your lender is, really well.
One other thing you can do as a buyer is do your homework on the lender. As I have said before, when you get that contract accepted, and your lender sends over someone from their pool of appraisers, it’s really helpful to know who is in that pool and how someone gets in it.
Why? It’s because not all lenders are created equal. Many banks, the huge institutional lending arms in this country, have really broad-reaching geographies and huge appraiser pools. The same is true in California. Some people who do appraisals here in the Bay Area live in the Central Valley or, in some cases, way up in Tahoe. It’s a very, very wide net in some situations.
Now, what you want to make sure happens is you talk to that lender when you’re doing your interview process. Find out who their pool of appraisers are, who gets to be in their pool, and what qualifications they have. Some qualities you could look for on the appraisers may be:
- They live within 10 miles of the subject property.
- They have been appraising for ten or more years.
- Or they have a particular qualification, license, or set of specialty for the area that’s appropriate for you.
Because somebody who doesn’t know the nuances of this market will have a hard time appraising the property accurately, especially here in the Bay Area. In the East Bay specifically, we have many custom homes and we trade as is. Thus, it is not like model Plan A, B, C, and D, then you just do a few upgrades, and you’re done. On a one-by-one basis, you really have to figure out what this home is worth, and it’s not that simple.
Quality > Quantity
Another thing you might want to hear is that it’s a smaller pool of appraisers who are maybe more high-skilled, more familiar with those properties, and have been doing it in a given neighborhood or geography for quite some time. That sort of thing is really one of the biggest things that gets overlooked in this whole appraisal conversation.
I promise you, if you ask that question upfront, get clarity, and then choose a lender who has not only a good rate but can actually get it done on the appraisal side, you have given yourself a distinct advantage when it comes to negotiating.
An anecdote about appraisers I hope you can learn from
Someone I know went with one of the bigger institutions instead of one of the local lenders who has that tighter appraisal pool. They went with someone who said could get them a slightly lower rate. For argument’s sake, it was about $75,000 less in interest over 30 years. Per month, that translates to a couple of hundred bucks. Because that bigger institution or lender had a wide pool of appraisers, the assigned appraiser came from over 100 miles away. The result? That appraiser came to appraise the house and ended up coming in $200,000 short of the buyers purchase price.
I mean, for one, this appraiser, used the listing prices as opposed to calling the listing agent and finding out what it’s actually under contract for as an appraised value. We all know that those prices are teaser prices, which means they’re artificially low. Therefore, as a result, they got a super low appraisal value. There were also some issues about how much square footage was measured, so it really skewed the data badly.
In the end, there’s a $200,000 shortfall in an effort to save a couple of hundred dollars a month on the rate. In over the lifetime of that loan, that someone has to come up with the $200,000 shortage today just to save $75,000 over 30 years, right? The conclusion? The ease of getting these deals done and the ability to negotiate in a strong position really matters.
I hope my blog on the appraisal process and what you can do to avoid getting an appraisal lower than the purchase price has helped you.
If I can give you more context on the process of buying or selling your home, please do not hesitate to reach out. My information is below.
Here’s to all your success!