You’ve been pre-approved for home financing, found your dream home, and made an accepted offer of $220,000; now what? Whether you are buying a home, refinancing your mortgage, settling a legal issue, or appealing property taxes, the value of the property in question needs to be determined through a home appraisal.
A home appraisal is required in mortgage lending to protect both the buyer and lender in a purchase transaction. If that $220,000 home is only valued by a licensed appraiser at $175,000, a buyer or lender wouldn’t want to be stuck with a property worth less than their investment. For homebuyers, appraisals put logic into the sometimes-emotional process of homebuying.
Methods of Approaching Value
To determine a property’s market value, an independent, licensed appraiser will present their unbiased opinion and analysis in an appraisal report. To get there, an appraiser will use one of three common valuation methods:
- Cost Approach – what it would cost to replace the improvements, less physical deterioration and other factors, plus land value. This is often the most accurate market value method for new property.
- Comparison Approach – making a comparison to other similar, nearby properties which have recently sold. Typically, this is the most accurate approach to determining value for residential property.
- Income Approach – an estimation of what an investor would pay based on the income produced by the property.
What the Appraisal Includes
Appraisal reports are very detailed and include some of the following factors of value determination:
- Details about the subject property
- An explanation of how the appraiser determined value
- A side-by-side comparison of the subject property and at least three comparable properties, also known as “comps”
- Physical, functional and external issues or features the appraiser sees contributes or impacts the property’s value. An example of a physical issue would be a leaky roof, a functional issue would be an insufficient bathroom-to-bedroom ratio, and an external issue would be a home located near a sound obstruction, such as an airport or train station.
- An evaluation of recent market trends in the area affecting value
- Area in which the home is located (condominium project, duplex, acreage, PUD development, etc.)
- Notations of seriously flawed characteristics, such as damaged foundation or a wet basement
- Photographs of the property
Documenting the Home
An appraiser gains their knowledge of the subject property during a walk-through, in which they make notations and take photos and measurements of the property. The appraiser may also ask the current homeowner for information about the property that may affect valuation, such as invoices of recent remodeling projects or upgrades, surveys and blueprints, and documentation of homeowner’s association dues (if applicable), utility bills, costs of taxes and insurances, etc.
Looking for more information about the home buying and financing process? Download our free Mortgage 101 Handbook for a great reference on all things homebuying.