In my last installment of DTA, I address the role and motivation of appraisers. These professionals are the ones who supposedly protect the bank and the borrower from overspending on a real estate purchase. Appraisers are paid a flat fee by the buyer to compare the property under contract to nearby homes with similar features and come up with “fair” value. How do you value something that is unique and changes in value depending on the federal interest rate? In 2008, every home that went into foreclosure by a bank was appraised by a licensed appraiser. The appraisers were over-valuing the home. After the housing crisis, government reforms now require banks to reach out to appraisal management companies (AMC) which select the appraiser at random. Banks have an incentive for the loan to close so it can be sold so what would happen if an AMC kept returning appraisals that were lower than the contract price and wouldn’t close? The bank would choose another AMC for their loans. In addition, the appraiser sees the contract price between the buyer and seller before making the appraisal. The appraiser now knows the price needed to close the transaction. Did your teachers in high school give you the exact answer before the exam? But that’s what happens when someone buys a house!
Although the appraisal method is flawed, it is the best of the worst options. Therefore as a buyer you can either trust the appraisal or better yet come up an appraisal value using Zillow. Jamil Damji provides a practical 10 minute video on how to appraise a home. I use this every time I make an offer. If you are going to use a flawed method, you should at least know what assumptions were made. Although every house is unique, it has basic features such as number of bedrooms, bathrooms, location, age, etc. that can be compared. The flaw in most appraisals is the amount you can overvalue or undervalue each of these features relative to the comparable. When estimating a property value, I look at what it is worth now but also what it was worth a year ago to see how the market is trending. Regrettably, looking at previous sales is the only way to get an accurate value. A house is only worth what someone will pay for it.
On closing day, if you read through a purchase sale agreement, all of the obligation clauses (e.g. “shall”, “agrees to”, “will”, etc.) apply to the buyer so no matter how much you rely on any of the professionals involved with your home purchase appraiser, you the buyer are obligated to pay the loan. There are no refunds and no exchanges!
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