What is an Appraisal Shortfall?
Appraisal shortfall is simply a lower appraised value than the sale price of the home. Ideally they should match or the appraised value can be slightly higher. The buyer can only borrow from a lender based on the appraised value of the home. If an appraisal shortfall occurs, someone needs to pay the shortfall. The question is who?
An explanation of the Home Appraisal Process
Once a contract for sale is signed, the buyer’s agent forwards the sales contract to the lender. The lender then collects $450 from the buyer via a credit card and orders the appraisal. The appraisal inspection is then scheduled by the appraiser with the listing agent. The Appraisal process typically takes 6-12 days. It takes approximately 3 days from the date the appraisal is completed for the buyer’s agent to receive it. The buyer’s agent then informs the listing agent of the found value and whether the property appraised out or not. If the appraisal is short, the listing agent will request a copy of appraisal. If the appraised value is over the sales contract price, the buyer’s agent typically informs the listing agent of the exact value but doesn’t provide a copy of the appraisal. If the appraisal is short, then the listing agent and seller mull over the report analyzing the appraiser’s chosen comparable sales.
How do they happen?
Due to the 2006 housing bubble, rampant mortgage fraud and the subsequent housing crash, Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in 2008. It mandates appraisers be chosen from a blind pool of appraisers as opposed to lenders and others steering an appraisal order to a particular appraiser.
Since appraisers are chosen from a blind pool they may or may not be from the local area. That being said, an out of area appraiser may not be familiar with local neighborhoods. But, this can work the other way as well. A local appraiser that has extensive local knowledge may prejudice the appraisal because the local appraiser might have personal stigmas about certain streets or neighborhoods while an out of area appraiser won’t.
Appraisal shortfall seems somewhat random. The Altru Team carefully analyzes every transaction for appraisal shortfall risk before an offer is accepted. There are times when an appraisal shortfall is expected and there is none and visa-versa.
The biggest reason for an appraisal shortfall is a lack of comparable sales to support the contract price. If the market is always looking backwards in time to find past sales to support new sales then how would the market ever move up if all new sales are dependent on appraisals using old data? Cash sales do not require an appraisal but mortgage sales do. Appraisers do not necessarily see or agree with what a buyer sees as value and of course varies from what sellers think as well. If a home is one of the best homes in the neighborhood that type of home rarely will appraise out. Or, if a home has hurricane impact windows, $60,000 outdoor kitchen, $100,000 pool, $70,000 kitchen, solar panels, water filtration systems and other niceties it too will likely never appraise out especially if the homes around it are just A to A+. Homes that are A +++ need an appraisal shortfall hedge before a contract is signed.
As well, if you had three different appraisers do an appraisal on the same property the result will likely be three different values especially on more expensive homes. But, homes under $200,000 will likely all appraise out in a rather tight range of value because less expensive home are more comparable such a track home construction.
Appraisals and different loan types
Mortgages vary as to what the borrower has to pay as their down payment. A VA loan can be 100% of the appraised value, FHA 96.5%, Doctors loans 100%, USDA 100% and conventional financing varies from 95%-80% loan-to-value.
VA loans have an appraisal shortfall safety component known as Tidewater which mandates the VA appraiser reach out to the listing agent for additional comparable sales data before finishing and publishing the appraisal should there be a shortfall. For that reason, VA loans are actually a positive for a seller, buyer and listing agent. An FHA appraisal might be the most difficult to manage because the appraisers typically will not change the valuation should there be a shortfall. The FHA appraisal itself sticks with the property for 6 months following the completed appraisal. Often, FHA appraisers fail to input that data into the tracking system so just because one FHA loan or appraisal came in short doesn’t automatically mean another FHA buyer is stuck with that appraised value. Conventional loans are a bit easier to work with than FHA.
Solutions to Appraisal Shortfalls
- The buyer and seller can meet in the middle. The seller can reduce the sales price while the buyer comes up with more cash so that they meet in the middle.
- Sometimes the buyer already has enough cash in the transaction and only needs to reduce their loan to value ratio.
- Some buyers don’t have additional funds and often request that the seller reduce the sales price to meet the appraised value. Many listing agents surprisingly support this.
- Most sellers would prefer the buyer close the transaction at the sales price and pay the appraisal shortfall in cash. There are buyers who love the home and understand that some homes are worth more to them than the appraisers opinion or value and will close the transaction accepting the appraisal shortfall.
- Sellers and buyers can request a second appraisal typically paid for by the lender but at times the buyer or seller may have to pay. This would be a consideration on more expensive homes.
Preventing an Appraisal Shortfall
Hire a listing agent that understands how to manage an appraisal shortfall risk for a seller before a contract is signed. That is what we do at Altru Realty. There is a saying around here “appraisals are for lenders not sellers.”
Appraising is an artful process and working through the maze of data to figure out if a particular home is an appraisal shortfall risk is a job for a highly skilled negotiator. Each negotiator at Altru Realty has achieved a status called Certified Altru Negotiator which is our internal standard we set for possessing the minimum competence to negotiate for a seller. Altru Realty doesn’t negotiate for buyers because Altru Realty uses single-agency (fiduciary) to a seller. If a buyer wants to make an offer directly through Altru Realty they can but we do not represent the buyer in any capacity. We engage buyers using a no-representation agreement.
At Altru Realty we are always building an appraisal shortfall case for each property using all possible sources of data. We are listening carefully to buyer’s agents opinions about appraisal shortfall which they always offer up without any solicitations. If we believe we have an appraisal shortfall the appraisal shortfall alarms will sound and we take action.
Most listing agents do not concern themselves about managing the risks associated with an appraisal shortfall and believe this is a seller and buyer risk or just a market dynamic. In other words, let the process play out. At Altru Realty, we manage this appraisal short risk differently actually passing this risk back to the buyer whenever possible through special language in the contract. Our vetting process actually entails choosing a buyer that agrees upfront to accept a certain appraisal shortfall. That amount may be a little as $5,000 or as much as $150,000 depending on many factors including the quality and uniqueness of the home.
To list your home with Altru you can contact us at (888) 392-4806