For example, if you’re buying a home with a mortgage, your lender will require an appraisal to establish the home’s value—which helps determine the loan amount and how much you’ll be able to pay for the home. The appraiser then establishes a market value for the home, which the lender uses—the buyer and seller generally end up renegotiating the sale price if the appraisal is different than the sale price.
How Home Appraisals Work
When you’re buying a home and need an appraisal for home mortgage financing, you usually wait until you have an offer accepted by the seller. At that point, your lender will find an appraiser with strong appraisal credentials, with licensure or certification through the Appraisal Foundation. This appraiser will evaluate many factors related to the home, both inside and outside. They’ll look at past sale history, comparable houses in the area, their recent sales prices, and any upgrades or damage to the home. Then they’ll generate a report which justifies their final appraised value.
Types of Appraisals
There are three types of appraisals, each of which is used for different real estate transactions. It helps to know the difference so that you can understand what an appraiser might be evaluating. Appraisers take different approaches when valuating a home.
Cost Approach
The cost approach appraisal is generally used for newly constructed homes by home builders and developers. This approach uses the costs of building the home, such as labor, materials, and lot value then subtracts any depreciation.
Sales Comparison Approach
The sales comparison approach is the valuation method used most by real estate appraisers. This model uses the condition, location, size, and unique characteristics and compares them with comparable homes in the area.
Income Capitalization Approach
Income capitalization is not typically used in residential real estate transactions. This approach is geared toward commercial properties or properties being purchased to generate revenue—such as buying a home to use as a rental.
Do I Need an Appraisal?
Not all real estate transactions require an appraisal. For example, if you have the financial ability to purchase a home with cash, you won’t need an appraisal. However, you might want to consider having one done to ensure you’re paying what the home is worth on the market—not what it’s worth to the seller. This is because seller value and market value can be significantly different. You may need an appraisal if you’re refinancing the home you already own. Homeowners sometimes replace the mortgage on their home with one that has a lower rate or to get lower monthly payments. If you’re considering a home equity loan for home improvements, starting a small business, or other reasons, your lender may require an appraisal to make sure that the home has the equity needed to finance the loan.
