Even if you’ve gone through the process of purchasing real estate several times, you may still ask yourself, “how do home appraisals work?” Briefly, a home appraisal is an expert’s evaluation of how much a property and its structures are worth. To further explain the concept, it’s helpful to understand some of the reasons behind obtaining this type of assessment.
Affect on Mortgage & Lending
Probably the most common reason for having a home appraised is because it impacts the amount a lender is willing to loan to purchase a property. A buyer might have the best credit in the world, and have come to agreement with the seller on a price. Even so, the bank will not automatically loan funds without knowing the value of its collateral. If the home is appraised at a much lower value than the loan a lender has pre-approved, the institution risks being stuck with a property worth less than its investment.
Therefore, obtaining an evaluation is a key component of any real estate transaction. However, to really grasp how home appraisals work, you can look at the different methods experts use to complete them.
Sales Comparison Approach
One way to evaluate a home’s worth is to compare it to other similar properties in the area. In conducting a Sales Comparison Approach, an appraiser will review recent home sales for places that are comparable in size, number of bedrooms and bathrooms, age, amenities, and other qualities. These “comps” should be in the neighborhood surrounding the subject home, as the location also affects the accuracy of the report.
A second method for determining a home’s value is mostly used for new construction. The Cost Approach calculates how much it would cost to replace the home if it were destroyed for some reason. An appraiser will also review the land value to get a full picture of the property’s value.
Once the appraiser has completed the assessment, they will generate an Appraisal Report based on their findings. It will include a dollar value, as well as the information the expert reviewed in order to come to their conclusion. Among other things, the Appraisal Report will include:
• An identification of which approach was used in the appraisal process, either the Sales Comparison or Cost Approach;
• A description of the home itself, including square footage, the year it was built, the size of the lot, and any major improvements;
• The condition of major structures and systems, such as the roof, the heating, ventilation and air conditioning (HVAC), plumbing and electrical;
• Identification of any significant damage or structural problems that would require additional investment to repair; and,
• Notes regarding the neighborhood and trends in the region’s real estate market that impact a home’s value.
This general overview should help answer the question, “how do home appraisals work?” However, these are just a few of the details that professional home appraisers focus on to come up with an accurate and reliable assessment that will lessen a bank’s risk.