How Home Valuations and Appraisals Work

By Mark Nash
HomeFinder.com

Article highlights:

Determining a home's value
Appraising a home using two approaches
Figuring mortgage loans with appraised value

Most home buyers and sellers assume that when they agree to a home's value — or fair-market value — it becomes written in stone as the contract price.

But then the real estate appraiser hired by the buyer's mortgage lender comes up with his own value, which may match the contract price, or be higher or lower. In determining a property's current value, an appraiser will consider recent sales of similar homes in the area and will compare those that have sold only in the last six months.

An appraisal is an unbiased estimate of what a buyer might expect to pay for a property. Here's how the process works:

The mortgage lender, and home buyer and seller turn to a licensed appraiser to provide an accurate estimate of a home's value. If the home appraises for less than the contract price, the mortgage lender will only loan the amount of money that is based on the property's appraised value. The buyer and seller must then agree on how the shortfall will be met: Either the buyer must put down more money or the contract is modified to reflect the lower appraised price.
The appraiser visually inspects the features, number of bedrooms, bathrooms, location, condition, remaining useful life and other factors that could affect a home's value. Rooms are measured, diagrams are drawn, photos are taken of the property, and then the appraiser prepares his report. (The appraisal inspection is not the same as a physical home inspection, which looks for any defects of a home and faulty equipment such as electrical and heating systems.)
After the inspection, the appraiser establishes value by using either the 'cost approach' or the 'sales comparison.'

The cost approach takes available information available such as local building costs, labor rates and other factors to determine how much it would cost to build a similar or comparable home.
The sales comparison approach relies on recent sales in the area and assesses properties that are comparable or similar in age, style, condition and location. But what if the home you're buying doesn't have the classy stone fireplace that house down the block has? In that case, the value of your home is lowered. On the other hand, if your home has a mud room but a similar house doesn't, then your property's value is pushed up.

4. The appraised value is then used as a benchmark for lenders who don't want to loan a buyer more money than the home is actually worth.

Next article: The Ins and Outs of a Home Inspection >>