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Appraisal management companies are the bane of a buyer’s existence. This is the biggest problem right now for a buyer who is getting a loan and will need to have their future home appraised. Here is exactly why this will be your biggest challenge, and I’ll tell you how to handle this issue.
The mortgage debacle that was part of the real estate crash a decade ago gave politicians all the encouragement they needed to pass new laws restructuring how appraisers are hired. You may recall that the complaint was that a very small number of appraisers were in cahoots with a small number of real estate agents and they were committing fraud by over valuing homes. The best answer would have been to require enforcement of the laws against fraud, i.e. put the frauds in jail.
Instead, politicians completely restructured the entire mortgage and appraisal business in the United States, and they authorized new entities called “Appraisal Management Companies.” These companies are third party entities that appoint appraisers from a list they create. They charge appraisers a fee to be on their list, and they take part of the appraisers’ fees for each appraisal they do. Appraisers hate this new way to extort money from them. It’s another layer of bureaucracy and more fees that are simply passed on to buyers. (more…)
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Fair market value is the true value of a home, and when you buy a home, clearly you don’t want to pay more than fair market value. That may be an obvious statement, but what is not so obvious is how to know the fair market value of the home you want to buy. When you discuss drafting an offer with your buyer’s agent, you’ve got to be very good at figuring out what the true fair market value is (or at least your Realtor needs to have that skill).
In a large market, like Tacoma or Seattle, you will have thousands of homes in the multiple listing service (MLS) inventory, and you will also have hundreds of sales every month. A 3 bedroom, 2 bath, 1,800 square foot home in a middle class neighborhood will be easy to analyze. There will be dozens, if not hundreds, of homes that are almost identical and which sold in the last six months, and so coming up with an accurate fair market value is easy, and it’s easy to identify the average time period it takes to sell a similar home.
But in a very small market with a small inventory and a small number of buyers arriving to look at homes, many homes in the Sequim inventory do not have comps. In other words, there may be no homes recently sold like the one you want to buy, so fair market value cannot be calculated with any certainty. The math can get a little fuzzy when you don’t have comparable sales.
Even professional appraisers don’t have any magic wands in a market lacking comparable sales data. One has to be a bit cautious on this subject, because some sellers and some listing agents may think they know the fair market value, but they may just be guessing. On the other hand, there may be a particular house that does have 5 or 6 good comps, and then fair market value is easier to understand.
When you discuss drafting an offer, discuss value from a number of perspectives with your buyer’s agent, because your offer should be no higher than fair market value.
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What happens if get a low appraisal that comes in below your purchase price? This could turn into a nightmare scenario, but there is a seasoned approach to handling a low appraisal. First, we’ll look at the immediate consequences, and then we’ll look at the solutions.
It does not happen very often, but once in a great while a low appraisal comes in below the purchase price. When that happens, the contract language provides options for the buyer and seller. Upon receiving a low appraisal, the buyer issues a Notice of Low Appraisal to the seller. The Notice of Low Appraisal presents the seller with three options:
Option 1: Seller hereby gives notice that a reappraisal or reconsideration of value has been completed in an amount not less than the Purchase Price. Buyer shall promptly seek lender’s approval of the reappraised or reconsideration of value.
Option 2: Seller hereby consents to reduce the Purchase Price to $______ (an amount not more than the amount specified in the appraisal or reappraisal by the original appraiser, or an appraisal by another appraiser acceptable to Buyer’s lender, whichever is higher).
Option 3: Seller hereby gives notice that Seller rejects Buyer’s notice of low appraiser and (1) will not cause a reappraisal or reconsideration of value to be completed; and (2) does not consent to a reduction of the Purchase Price.
While these look like logical options for a seller, and they are, there really is only one practical option for a seller in this real estate market: lower the price to match the low appraisal value. Why is this the only practical option?
I represented a buyer in the purchase of their home in Sequim, and the appraisal came in $30,000 less than the agreed price, which was just under $400,000. That was a surprise to all of us. The sellers were quite disappointed naturally, but here’s why their only practical remedy was to accept the lower price.
The buyer’s lender will only extend a loan based on the loan to value ratio (i.e. 80%) of the purchase price or the appraisal value, whichever is lower. The only way a buyer could pay a higher price above the appraised value is if the buyer came up with the additional cash for the difference. In this case, the buyer would have to come up with their 20% down payment of the appraised value plus an additional $30,000 in cash to make up the difference. That simply doesn’t work for most buyers, and buyers would generally be adverse to paying more than the appraised value anyway.
If a seller chooses the reappraisal option, the entire closing will have to be extended for weeks to have time for another appraiser to come in and then what do you get? You get a second appraisal that probably comes in fairly close to the first appraisal since they are using the same sales comps and replacement costs in their evaluation. If the second appraisal comes in higher, you would still have the challenge of getting the buyer’s lender (the underwriter) to accept the second appraisal, and that simply may not happen. Meanwhile everyone’s plans have been delayed by weeks, and the buyer’s are in a nightmare scenario, because they have no place to live during all of this, and the seller’s probably packed everything up in boxes and are practically moved out of the home. In addition, the sellers are also probably buyers for a home where they intend to move to, and that is means they have another pending transaction that will have to have the closing date extended, and that might not work for those sellers.
In my buyer’s transaction, the sellers did agree to reduce the price by $30,000, and everyone will be able to move on with their plans. A low appraisal is rare, but when it does happen, it is unfortunate for the sellers especially. The practical solution in most cases of a low appraisal is for the sellers to agree to reduce the price. There are exceptions to this rule, but those exceptions are as rare as the low appraisal itself.
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How important is sellability and appreciation in your home? Extremely important, and I’ll tell you why. Too many widows in their 80s have been left with a home they cannot sell, and it becomes a nightmare for them when they are struggling to maintain the property and pay property taxes. I’ll explain what has happened to many couples who built or bought a home that was not sellable 15 to 20 years later.
You have to assume that you will “age out” of your home (probably in your 80s or 90s), and logically you will need to sell it when you get old. In order to sell your home in the future, there are two critically important things that must happen, and whether they happen or do not happen depends on the decision you make today about the home you buy.
Before you will ever see any appreciation, you must be able to sell the home you will live in for the next 15+ years. So when you buy a home, you need to carefully consider how sellable it will be down the road. This is no small matter, and many people have screwed this up. That’s why I’m writing about this now–to help you as a buyer think this through so that 15 to 20 years from now, the sale of your home will go smoothly.
Many couples built or bought their idea of the perfect home, but 15 to 20 years later they were unable to sell that home when their husbands either had health issues or predeceased the wife. [More often than not, it is the husband’s health that fails first.] A non-traditional floor plan is predictably hard to sell. A more traditional floor plan is not so hard to sell. Weird or too unique is hard to sell. A single level, 3 bedroom, 2 bath home between 1,800 and 2,400 square feet with an open floor plan (kitchen, living room, and dining room) is very sellable and is appealing to the vast majority of buyers, which makes it fairly sellable 15 to 20 years from now. You don’t have to buy a home exactly like I’m describing, but you get the point. There is a Bell Curve of normal homes, and as you get further out on that Bell Curve, the homes become less sellable.
If you cannot sell a home when you are old, you will never see any appreciation, and the financial strain and the stress it would cause in your life would be a potentially devastating nightmare. This is why buying a home now that is sellable two decades in the future is definitely in your best interest. Appreciation is important, but sellability is everything.
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What happens if the home you are buying gets a low appraisal? This might surprise you, but a low appraisal is more likely to happen in a rising market with increasing prices and especially a very hot market. That’s because appraisers are using data that may be six months old when they compile comparable sales, and their prices are simply outdated. So what happens if you do get a low appraisal?
If your appraiser comes in below the sales price that you and the seller have agreed upon, you can ask the seller to reduce the price. In a very weak real estate market, or at least in a market that is not doing anything, a seller is likely to agree to reduce the sales price to the amount of the appraisal. But in a stronger market, the seller may say no, in which case a buyer has a couple of choices. Since the buyer’s loan is based on the sales price or the appraisal, whichever is lower, the buyer would have to come up with the difference in cash. If they cannot or are unwilling to do that, the buyer can walk away from the transaction.
The seller could request a new appraisal, and there is a process for determining which appraisal is acceptable to the loan underwriter, but that process is a rather involved re-appraisal and battle of the appraisers. Everyone could end up in the same place as the above scenario with the buyer either coming up with the cash difference or walking away from the transaction because of a low appraisal.
Right now in the Sequim real estate market, I have seen a low appraisal more than once, and it creates quite a stressful situation for everyone at the 11th hour. Some sellers are refusing to lower the price, because they have backup offers at full listing price and one even had a cash offer above listed price. That’s the kind of market we are in now. You can hope you get a good appraiser who actually understands how to properly evaluate a property in a rising market. In the vast majority of cases, the appraisal comes in at or just above the selling price, and then we don’t have to fret over a low appraisal.
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Bell Hill homes are selling once again after a bit of a lull in the past few years. Prices are down and demand has increased of late. How can you know how much to offer on a nice home? In this article I want to show you how the tax assessed value relates to the listed price and the actual sales price. Since the tax assessed value is available online, it is helpful. This graph shows ten Bell Hill homes and compares the listed prices with the sales prices with the tax assessed values.
Enlarge this graph by clicking on it. The blue bar represents the original listed price, the green bar represents the actual sales price, and the orange bar represents the taxed assessed value prior to the sale. It will be no surprise to you or me that some of the listed prices were much too high. What is interesting is that the actual sales prices are much closer to the tax assessed values, but I need to qualify how to interpret this data.
This does not mean you can look at Bell Hill homes for sale and expect to buy one for exactly the same price as the tax assessed value, although that is what happened with home No. 3. As you look at the enlarged graph, you’ll see that some homes sold above the assessed value and some Bell Hill homes sold below the assessed value. The above Bell Hill homes sold for 6% less than assessed value to as much as 22% above assessed value. Taking out that extreme of 22%, the average range is plus or minus 6%. While this is not definitive, it is interesting to know that many Bell Hill homes are selling within a range of 6% above or below the tax assessed value. Obviously, there will be exceptions.
Having said that, there is much more to evaluating a property and determining fair market value. I recommend my book on this subject that details the several methods you can use to analyze price and determine true fair market value in any market. That book is available in the Apple iBookstore store, and the title is Buying Your Retirement Home (Book 2). Of course, if I have the privilege of working with you, I help you evaluate values on Bell Hill homes.
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Are faulty home appraisals killing deals? The answer is yes, but this issue requires careful consideration to understand what is going on and why. At the outset, let me say the problem is less about professional appraisers than it is about a system that is defective. Like every profession, there are a few incompetents, but 99.9% of all appraisers are both highly competent and honest. The real problem goes much deeper. Perhaps this real life example in Sequim, Washington will help clarify the problem and the issues.
I sold a home in Sequim, Washington that never closed because of these issues with home appraisals. This home was originally listed at $850,000 and after two and a half years on the market, the listing price was reduced to $500,000. That’s when I helped my clients negotiate a price of $450,000. The home was appraised, and lo and behold, it appraised for exactly $450,000. The underwriter subsequently rejected the appraisal, saying that the six comparables in the appraisal report were insufficient because they were not all sales within the past six months and they were not within the maximum radius.
Appraisers are challenged to find good comps in this recession. A good comp is a similar home with similar features in a similar area. In smaller markets, like Sequim, Washington, comps can be few and far between. That means a loan underwriter may simply reject the appraisal, and the transaction is dead.
The appraisal industry is reeling from the effect that short sales and foreclosures are having on real estate values. It seems clear to me that a garage sale price on a foreclosure should have no more impact on regular home sales than a garage sale behind Walmart has on their prices. In other words, desperate foreclosure sales should not be included as comps for appraisal and lending standards. (more…)
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Many people know the appraisal business is in a time of tremendous challenge. Most people have heard stories about the problems that buyers are having getting loans and getting underwriter approval. As with most things in life, things are not always what they seem. The appearance is not always the reality. This is true in the appraisal and mortgage business. These are weighty issues, because what happens in the appraisal business effects both buyers and sellers.
Traditionally the appraisal business is based on math. An appraiser compiles data on a property, the cost of replacement and comparables, and he does a detailed analysis to arrive at an appraised value. The appraised value is theoretically the current fair market value, a price at which the property should sell for, and upon which a mortgage company can base their loan to value formula to arrive at a maximum loan amount. In the business, we often like to say that an appraisal is as much art as it is science, because we all realize that there is room for different opinions by appraisers as to the precise value of a property.
While appraisers play a background role and do not get any glory for their work, the entire mortgage business is built upon the credibility and accuracy of appraisals. In fact, not only is the entire mortgage industry built upon the accuracy of appraisals, so is the secondary mortgage market, the mortgage derivative market, and the billions of dollars invested in various mortgage instruments, like REITS. Retirees have billions of dollars invested in mutual funds that have also invested in mortgage backed instruments. A lot is riding on the accuracy and credibility of appraisals.
There are cracks appearing in the appraisal business, and the mortgage industry is now facing some serious challenges in the way business has always been done. I’ve been watching how the appraisal business works since I first became a Realtor 37 years ago. I noticed then in Fairbanks, Alaska how the appraisals always seemed to come in just slightly above the actual sales price. After a few dozen transactions as a Realtor, I thought that was an interesting coincidence. After several hundred transactions over 37 years with 99.99% of all appraisals coming in exactly equal to the sales price or slightly above it, I no longer believe in coincidences.
We all understand and are led to believe that appraisals are objective third-party determinations of value. The entire appraisal business, the entire mortgage industry, and the real estate financial markets are built upon that firm foundation. Alas, the foundation has a serious crack in it, and there really is no such thing as an objective third-party determination of value. What we do have is perception. The perception that the appraisals determine true fair market value is nothing more than a belief that if an appraiser says so, it is so. Let’s forget about the fact that the appraisers always find out the sales price and then bring the numbers in at or above that amount. (They will deny this to the ends of the earth, but I am certain this is true.)
I know many excellent appraisers. They are honest men and women of integrity. But it is not the people I write about here as much as the “system” in which they work. The system is full of cracks. What does all this about the appraisal business mean for buyers and sellers today? It means the system is built upon perception of value, nothing more. As buyers and sellers, all you can hope for in your next transaction is that when your appraisal comes in, it will satisfy an underwriter, which itself is a nightmare in the current environment. Underwriters. Now that’s a topic for another day.
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Home appraisals are out of control, and if you’re buying a home in Sequim or Port Angeles, you may find yourself in a most impossible situation like recent clients of mine did. What if you were told the home you want to purchase cannot be appraised? That would sound ridiculous, wouldn’t it? Well it happened, and here are the facts.
A retired couple pre-qualified to buy their home in Sequim, and the agreed sales price was about $200,000 less than the county tax assessment, and it was also about $200,000 less than it’s peak value in 2005. The appraisal came in very conservative and precisely at the already low purchase price. The cost of replacement would be about $100,000 more than this appraised value. Even the comparables in this appraisal were priced very low in this real estate recession. So the appraised value was very conservative, and should have made any bank feel secure, especially with qualified buyers coming up with a huge down payment.
Instead, the bank’s underwriter rejected the appraisal, and they argued that the most recent sales of similar homes are insufficient to establish value. The underwriter wanted sales within 90 days and within a very small radius from the subject house. It made no difference at all to the underwriter that a small real estate market like Sequim’s simply doesn’t have more sales in this price range. They don’t exist, which means the next best comparables are similar homes that have sold further back, like 6 to 8 months, and perhaps 5 to 10 miles or more away. After all, this is the country, not Seattle or Tacoma. Even with comps, an appraiser must differentiate the subject property to establish value.
The deal is dead since the bank will not accept an appraisal based on actual sales in the area. This is an extraordinary result and shows how truly ridiculous banks can be! Home appraisals are out of control, which is to say the regulators and politicians are out of control.
Instead of local honest professional appraisers getting the job by referral, we now have an “objective system” of banks from outside the area hiring appraisal management companies from outside the area to appoint appraisers from outside the area to appraise a local home. How reliable do you think the appraisals will be with a system like this? The appraisal management companies will only include appraisers on their “appointment list” who pay the appraisal management company a “fee” and agree to a lesser appraisal fee. No wonder most of the long time honest appraisers with integrity in Sequim refuse to be part of that system.
Insane, isn’t it? This is how our politicians solved the mortgage fraud and appraisal problem, by making it so chaotic that either the appraisal your lender gets may be totally unreliable, or you may be told that the home you want to purchase cannot be appraised at all.
This is why I say home appraisals are out of control. My advice is to get the best mortgage broker you can find, and I know who they are, so you can email or call me. I also recommend that you know how to address the subject with your bank, how they will appoint their appraiser for your home, and the criteria they require for a Sequim appraisal. You have no control over how your bank appoints their appraisers, but you do have control over where you bank. Home appraisals are an area full of traps for the unwary these days.
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What do Sequim appraisers do when their assignment is an unfinished house or an incomplete house? I recently sold a home that was foreclosed and is new construction. This is in a subdivision that has been foreclosed. Unfortunately for the developer, he invested a fortune in subdividing land and building homes just as the market peaked in 2005. He hung on hoping upon hope that the market would turn around before the ball and chain of debt pulled him under. For the developer, this became his personal story of tragedy, but for my client, this became an opportunity to purchase a home at an extraordinary price. But the house was unfinished, so how did the appraiser deduct appropriate values to arrive at a true fair market value (FMV)? After all, my buyer had to be able to get a loan based on a solid appraisal.
Sequim appraisers do not have a huge database of comparable sales to use when they do their appraisals. There just aren’t very many sales that are truly comparable. Many Sequim homes are unique, and for those homes especially, there will be few and maybe no comparables. An appraiser will use what he has, including the cost or replacement approach, but the value that an appraiser will give the greatest weight to will be the prices of other recently closed transactions.
When a home is unfinished, an appraiser uses published estimates of the “cost to cure.” If there is no carpet and no flooring, as in the case of the home my client just purchased, the cost of a carpet and flooring is estimated using less expensive materials, but not necessarily the cheapest. Since the appraiser works for the bank (not the buyer), the goal is to arrive at a solid value that secures the debt. Banks don’t want inflated estimates, and appraisers’ reports are now subject to more scrutiny than ever before.
If a house has some unfinished minor work, such as touch up painting, some missing trim, or other inexpensive repairs, the appraiser may just ignore the “cost to cure.” Sequim appraisers are both experienced and conservative in their appraisals. This is good. Almost all banks now use Appraisal Management Companies to select appraisers, so local loan reps or Realtors are prohibited from having any influence with how the appraiser is selected. The appraisal process is probably more objective for Sequim appraisers now than it ever has been.
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What if the Sequim appraisal price is less than what you and the seller agreed to in your purchase and sale agreement (PSA)? Let’s say you find a home and you say to yourself, “Yes, I could live in this home for the rest of my life. It’s perfect.” You have your buyer’s agent write an offer. The seller counters, and you counter, and the seller accepts. You now have mutual acceptance, in other words, you have a contract. But suppose your bank orders the appraisal and the out-of-town appraiser appraises the home for $15,000 less than what you agreed to pay? Is there an acceptable solution for you as the buyer? You could pay the additional amount in cash at closing, but that’s not the kind of solution most of my client would pick.
Fortunately there is a good answer for you as the buyer. As a buyer’s agent, and having been a real estate attorney for 20 years, I can share the contract provision in the PSA that gives you the ability to negotiate a better price. The paragraph that saves you is para 6 of the Financing Addendum dealing with your Sequim appraisal:
6. APPRAISAL LESS THAN SALE PRICE. If Buyer’s lender’s appraised value of the Property is less than the Purchase Price, Buyer may, within 3 days after receipt of a copy of lender’s appraisal, give notice, which includes a copy of lender’s appraisal, of Buyer’s election to terminate this Agreement unless Seller, within 10 days after receipt of such notice, delivers to Buyer either:
a. A reappraisal or reconsideration of value, at the Seller’s expense, by the same appraiser or another appraiser, acceptable to the lender, in an amount not less than the Purchase Price; or
b. Seller’s written consent to reduce the Purchase Price to an amount not more than the amount specified in the appraisal or reappraisal by the same appraiser, or an appraisal by another appraiser acceptable to lender, whichever is higher. (This provision is not applicable if this Agreement is conditioned on FHA, VA, or RD financing. FHA, VA, and RD financing does not permit the Buyer to be obligated to buy if the Seller reduces the Purchase Price to the appraised value. Buyer, however, has the option to buy at the reduced price.)
If such appraisal, reappraisal, or consent to reduction of the Purchase Price is not so delivered, this Agreement shall terminate and the Earnest Money shall be refunded to Buyer. The Closing date shall be extended as necessary to accommodate the foregoing times for notices. Buyer’s waiver of the Financing Contingency constitutes waiver of this Paragraph 6.
Have you ever read something that gives you a headache trying to unravel its meaning? Lawyers write that way, and you have to read this several times before you finally can say, “I get it.”
In plain language, if your Sequim appraisal comes in less than the contract price, you give the seller the option to pay for a new appraisal, and if that comes in less than the contract price, the seller can reduce the price and make you happy, or the seller can refuse or not even respond, and the transaction is terminated. As the buyer, you have all the power in this re-negotiation. Now you know what happens if your Sequim appraisal comes in below your purchase price.
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The real estate appraisal business has taken a pretty big hit since the mortgage debacle. It used to be a good and well known appraiser could get referrals. In any profession, referrals are not only a good idea, but referrals became a major source of business for established pros. Referrals have been a good idea for consumers because you don’t choose by trial and error but by someone’s good experience, which is a good indicator that the person is honest and competent. And referrals were good for appraisers, because it is the least expensive and most effective way to get new business.
With the mortgage meltdown it was learned that a very very small number of appraisers had yielded to pressure from mortgage companies and banks to appraise homes above their fair market value in order to close loans. No one has come up with a statistic, but I think it would be reasonable to state that the vast majority of appraisers are honest and practice with integrity. It is probably less than 1% of the entire profession that would violate their oath by over valuing real estate. I think it’s fair to say that the small number of over valued homes was not the cause of the mortgage meltdown. If blame is to be assigned, it would better find its place in the mortgage industry and on Wall Street.
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