Everything You Need To Know About Home Appraisals
By Scott Nazareth
Getting an appraisal is a key part of the process of getting a mortgage. It’s one you should understand when you make an offer on a home, as the appraisal process can move quickly after you make a winning bid.
What is an appraisal?
Appraisals assess the current market value of a property.
Mortgage lenders sometimes require a formal appraisal to determine a home’s value for mortgage purposes — regardless of the price that has been paid for the property. They want to be sure a house is actually worth what they’re lending its purchaser.
This part of the buying process happens after your offer to purchase has been accepted, and before the mortgage has been finalized.
Who conducts an appraisal?
A licensed appraiser will determine the value of the home.
In Canada, there are two bodies that license and educate appraisers. They are the Canadian National Association of Real Estate Appraisers and the Appraisal Institute of Canada. Members of both associations are recognized by banks, credit unions, mortgage lenders, and mortgage insurers.
Lenders require that appraisals are done by companies on an approved list. A licensed mortgage broker ideally has knowledge of specific appraisers on the lender’s approved list and will be sure to choose one that is local, which ensures they’re up-to-date on neighbourhood factors that may affect a home’s value.
Who pays for an appraisal?
Usually, the purchaser pays the $300-$500 cost of an appraisal.
What is included in an appraisal?
An appraiser will study the exterior and interior of your property, as well as the land surrounding it. They will also consider the value of secondary structures located on the land.
There are three main ways to calculate the value of a property: the direct comparison approach, the cost approach, and the income approach.
The direct comparison approach looks at comparable properties that have been sold in the recent past. Making adjustments by looking at the details of each property, the appraiser assigns a value that the property would reasonably earn on the open market.
The cost approach is a less common way of determining value for residential homes. It’s used when relevant comparable sales data does not exist. This method takes into account the value of the land, plus how much it would cost now to construct a similar home.
The income approach is used for multi-unit properties, where the income related to the property is a key determinant of its value.
It doesn’t matter which method your appraiser uses. What matters is the final number, because that affects how much a lender will agree to give you.
2. Rental income
When you purchase a rental property, you’ll have to declare what rent you’re going to charge. That can be substantiated by providing a rental agreement with someone who already lives there, or someone who will live there when you move in.
If there’s no rental agreement in place at the time of your purchase, an appraisal will calculate the rental potential by looking at similar properties in the immediate vicinity.
An appraisal will include photos of both the exterior and interior of a home, including the attic, piping, and insulation. However, it’s important to note that an appraisal is not the same as a home inspection. They may report on similar things, but an appraisal should never replace an inspection.
When is an appraisal required?
An appraisal is typically not needed when borrowers put less than 20 per cent down because the lender can take comfort from the fact that the loan is covered by insurance. But in some cases — when the value or the condition of a property is in question — the insurer can request an appraisal.
Most borrowers who put more than 20 per cent down are not covered by mortgage insurance, so an appraisal is required. When the property is not insured, there is no guaranteed value in it and the lender needs some other form of assurance that the loan will be repaid. An appraisal is part of that.
But there are two ways to avoid an appraisal.
One way is to use the automated valuation model. There must be enough relevant data for this model, which looks at a database of comparable sales and determine if your property’s price is within an acceptable range.
The other way is when the loan is a small percentage of the total purchase price. If you’ve put 50 per cent down, your lender may waive the right of appraisal.
What happens if something goes wrong with an appraisal?
Certain factors in a property’s construction can reduce the appraiser’s calculation of its value. For example, vermiculite insulation, Kitec plumbing, UFFI insulation, and knob-and-tube wiring can all bring your appraised value down. This can make the property un-financeable for some lenders or may require it to be dealt with prior to closing or with purchase-plus or a hold back.
If an appraisal value is less than the purchase price, the purchaser must make up the difference.
For example, if you paid $749,000 for a home but an appraiser values it at $729,000, the bank will approve a loan based on the lower number. So you’ll have to come up with an extra $20,000 to make up the difference. If you can’t, you may no longer qualify to purchase the property.
Such a situation can be challenging on the short timeline of a home purchase, so it’s a good idea to have a contingency plan. It’s possible that you’ll learn that your home has a problem in the appraisal stage, and it’s never fun to be surprised at that point.
If you’re currently having challenges with an appraisal, contact us to find out how we can help.
Is it worth it to get a second opinion?
Yes. If you’re in doubt, it’s worth the peace of mind that comes with knowing your property was fairly and accurately assessed.
That’s especially true if your first appraisal comes in lower than expected. After a second opinion, the bank may choose one or the other of the reports, or they may take an average of the two. Either way, it’s worth knowing that your property was fairly assessed.
Does an appraisal affect my taxes?
No. It’s not the same as a tax assessment, and your home’s appraisal is not shared with tax assessors.
Do you have questions about appraisals or the mortgage process? Book a call to discuss how we can help with your mortgage needs.