When a first time home buyer enters the real estate market, he or she will encounter a number of unfamiliar terms. Understanding these terms can help a home buyer avoid costly mistakes during the negotiation and financing processes. Perhaps the least understood term is “real property appraisal.” Understanding the uses and mechanics of real property appraisals will eliminate much of the mystery in the home buying process.
What is an appraisal?
Homes, unlike many other assets, do not come with price tags. Before a bank or other financial institution will lend money for the purchase of a house, it wants to know the value of the property. An appraisal is the opinion of a qualified professional about the market value of the property. A bank may use an appraisal to decide whether to lend money to a prospective purchaser. If, for example, the appraised value of the property is $130,000, and the purchaser wants to borrow, say, $125,000, the loan may not be approved because the property does not have sufficient value to guarantee that the loan will be paid off. If the appraised value is $150,000, the bank may feel more comfortable lending the money.
How does an appraisal work?
The party requesting the appraisal, usually the lending institution, will hire a reputable appraiser to determine the value of the property. The appraiser will first inspect the property, taking careful measurements of each room and observing the physical condition of the property. The appraiser will also note whether the property has certain amenities, such as a swimming pool, an attached garage, or a back yard gazebo. The appraiser will then use one of three approaches to value to derive an opinion. The first approach, replacement value, is rarely used for residential buildings because these costs have probably increased to a far greater extent than the market price. If the property has a commercial element, for example, apartments, the appraiser will estimate the income stream of the property and will discount this income to derive the property’s present value.
The comparable sales approach
Neither the replacement cost approach nor the income approach to value are used for residential property. The most common approach is the sales approach. The appraiser obtains the prices for which comparable properties have recently sold. The appraiser then makes adjustments to allow for the physical condition of the properties and any significant difference in size. After making these adjustments, the appraiser will deliver his or her professional opinion about the fair market value of the property. This opinion is usually delivered to both the lender (the bank, in most cases) and the prospective purchaser.
Even the purchase of a relatively modest house can be a surprisingly complex legal transaction. The advice of a knowledgeable real estate attorney can be a source of great comfort for the first-time home buyer.