Imagine finding a home listed for $400,000. After touring the property, you decide it's the right one and offer $410,000. The seller accepts, financing is underway, and everything appears to be moving toward closing.
Then the appraisal comes back at $385,000.
You and the seller agreed on a price of $410,000, but an independent appraiser has estimated the property's value at $385,000. That $25,000 difference can suddenly become an important issue for the buyer, seller, and lender.
This is why the home appraisal is such an important part of many real estate transactions. An accepted offer establishes what a buyer has agreed to pay, but when mortgage financing is involved, the lender generally wants independent support for the property's value before providing the loan.
Understanding how appraisals work, what appraisers evaluate, and what options may be available when an appraisal comes in low can help both buyers and sellers prepare for this part of the transaction.
What Is a Home Appraisal?
A home appraisal is an independent professional opinion of a property's value. It is typically completed by a licensed or certified appraiser who evaluates the property and analyzes relevant market information before arriving at an estimated value.
For buyers using mortgage financing, the lender will generally require an appraisal before approving the loan. The purpose isn't to determine whether the buyer personally likes the property or whether the seller believes the agreed price is fair. The lender wants to determine whether the property provides sufficient collateral for the amount being financed.
Suppose a buyer agrees to purchase a house for $400,000. The lender doesn't simply assume the property is worth $400,000 because the buyer and seller agreed on that number. An appraisal provides an independent opinion that the lender can consider as part of its financing decision.
Why Does an Appraisal Matter?
The appraisal serves a different purpose for each party involved in the transaction.
For the buyer, it can provide additional information about whether the agreed purchase price is reasonably supported by the market. For the seller, the appraisal can affect whether a buyer using financing can obtain the loan needed to complete the purchase.
For the lender, the appraisal is largely about managing risk. A lender may be providing hundreds of thousands of dollars toward a home purchase, with the property serving as collateral for the mortgage. The lender therefore wants evidence supporting the property's value before finalizing the loan.
An appraisal doesn't guarantee that a buyer is getting a good deal, nor does it determine what the property will be worth in the future. It provides an opinion of value based on the property and available market information at that particular point in time.
What Does a Home Appraiser Look At?
An appraisal involves much more than walking through a property and deciding what it appears to be worth. The appraiser considers multiple characteristics of the home along with evidence from the surrounding market.
One of the most important pieces of that analysis is recent comparable sales, commonly called comps. These are properties that have recently sold and share important characteristics with the home being appraised.
An appraiser may compare location, square footage, bedrooms and bathrooms, lot size, property type, age, condition, garage space, finished basement space, and other significant features. Because no two properties are exactly alike, adjustments may be made to account for meaningful differences between the subject property and the comparable homes.
For example, a nearby property may be similar in size and age but have an additional bathroom or finished basement. Rather than treating the two properties as identical, the appraiser considers those differences when developing the opinion of value.
Size, Layout, and Property Condition Matter
Square footage is important, but an appraiser's analysis isn't limited to how large the house is.
The number of bedrooms and bathrooms, finished living areas, basement characteristics, and other property features can contribute to the analysis. Two homes may each contain 2,000 square feet but have different characteristics that affect how they compare within the market.
Condition also matters. An appraiser may consider the home's general quality, maintenance, age, and significant improvements. Major property problems can potentially affect value, and certain financing programs may have property-condition requirements that need to be addressed before the loan can move forward.
This doesn't mean every cosmetic flaw will dramatically lower an appraisal. Instead, condition is evaluated as part of the broader picture of how the property compares with other relevant homes in the market.
Location and Market Conditions Affect the Appraisal
A property's value is also connected to where it's located.
An appraiser may consider the neighborhood, surrounding development, lot characteristics, nearby influences, and relevant sales within the local market. This is one reason two homes that appear nearly identical can have significantly different values when they're located in different areas.
Current housing-market conditions also provide context. If buyer demand is strong and inventory is limited, recent competitive sales may support higher values. If more homes are available and comparable properties are selling for less, that information can affect the analysis.
An appraisal therefore reflects more than the physical structure. It evaluates the property within the context of the market in which buyers and sellers are currently making decisions.
What Happens During the Appraisal Process?
Once a buyer is under contract and using financing, the lender typically orders the appraisal. The appraiser then evaluates the property and conducts research into relevant comparable sales and market conditions.
After completing the analysis, the appraiser prepares a report containing the opinion of value and supporting information. The lender reviews that report as part of the mortgage approval process.
From there, one of three general outcomes can occur.
If a buyer agrees to pay $400,000 and the property appraises at $400,000, the appraisal supports the purchase price and the transaction can continue, assuming the remaining requirements are satisfied.
If the property appraises at $415,000, the agreed purchase price generally remains $400,000. The higher appraisal doesn't automatically allow the seller to increase the price. Buyers should also avoid viewing the $15,000 difference as guaranteed profit because an appraisal is an opinion of value and future market conditions can change.
The more complicated situation occurs when the property appraises below the purchase price.
What Happens If the Appraisal Comes in Low?
Suppose a buyer agrees to purchase a home for $400,000, but the appraisal comes back at $380,000. The transaction now has a $20,000 appraisal gap.
A low appraisal doesn't automatically end the sale. What happens next depends on the purchase agreement, financing, available cash, and what the buyer and seller are willing to negotiate.
The seller could agree to reduce the purchase price closer to the appraised value. In this example, that could mean lowering the price from $400,000 to $380,000. However, a seller isn't automatically required to accept that reduction.
The buyer may instead decide to bring additional cash to closing to cover some or all of the difference. This can become challenging because that money may be required in addition to the buyer's original down payment and closing expenses.
Another possibility is compromise. The seller might reduce the price by $10,000 while the buyer covers the remaining $10,000 difference. The exact solution depends on the circumstances and negotiations between the parties.
Can You Challenge a Low Appraisal?
In certain circumstances, there may be a process for requesting reconsideration of an appraisal.
This doesn't mean an appraisal can be challenged simply because the buyer or seller doesn't like the result. There generally needs to be relevant information worth reviewing, such as factual errors in the report or stronger comparable sales that may not have been considered.
For example, if the report contains incorrect information about the home's square footage or significant features, that could be important. Relevant comparable transactions that were overlooked may also be worth bringing to the lender's attention.
A reconsideration request does not guarantee that the appraised value will change. The lender and appraiser have processes for evaluating the information, and the original opinion of value may ultimately remain the same.
Can a Buyer Walk Away After a Low Appraisal?
Depending on the purchase agreement, a buyer may have options if the property doesn't appraise at the agreed purchase price.
An applicable appraisal or financing contingency may allow a buyer to terminate the transaction under certain circumstances. The specific rights and deadlines depend on the contract.
This is one reason buyers should understand their contingencies before submitting an offer—particularly in a competitive market where they may be considering an offer above the asking price.
For example, imagine a property is listed for $350,000 and receives several offers. A buyer offers $375,000 to win the home, but the appraisal later comes back at $360,000. The buyer has successfully competed for the property, but now there's a $15,000 appraisal gap to address.
The buyer and seller might renegotiate, the buyer could provide additional cash, or other contractual options may become relevant. Winning a bidding war and having the property appraise at the offer price are two separate issues.
Renovations Don't Always Equal Appraised Value
Appraisals can also surprise sellers who have invested heavily in renovations.
Imagine a homeowner completely renovates a property with a new kitchen, bathrooms, flooring, and landscaping. The seller understandably believes those improvements have made the home substantially more valuable and lists it well above other recent neighborhood sales.
Buyers may love the renovations and even agree to the asking price. However, the appraiser still needs market evidence to support the valuation. If there aren't enough comparable sales at that higher price level, the appraisal may come in below the contract price.
That doesn't necessarily mean the improvements have no value. It means the amount spent on renovations doesn't automatically translate dollar-for-dollar into appraised value. The market evidence still plays an important role.
Home Appraisal vs. Home Inspection
One of the most common sources of confusion is the difference between an appraisal and a home inspection.
Although both may occur during the buying process, they serve different purposes.
An appraisal primarily focuses on determining an opinion of the property's value, particularly for the lender. A home inspection focuses on the condition of the property and potential problems that may be important to the buyer.
An appraiser may consider the home's overall condition as part of the valuation, but that isn't the same as conducting a detailed home inspection. Having an appraisal therefore doesn't replace the role of an inspection during a purchase.
Final Thoughts
A home appraisal is an important part of many financed real estate transactions because it provides an independent professional opinion of a property's value.
Appraisers consider recent comparable sales along with characteristics such as location, size, layout, condition, significant improvements, and current market conditions. The resulting valuation gives the lender information it can use when determining whether the property sufficiently supports the requested financing.
When the appraisal supports the purchase price, this part of the transaction may pass without much attention. When the appraisal comes in low, however, buyers and sellers may have important decisions to make. A price reduction, additional cash from the buyer, negotiation, reconsideration request, or contractual exit may become part of the conversation depending on the circumstances.
For sellers, having a realistic understanding of market value before listing can help reduce the possibility of appraisal problems later. For buyers, understanding the appraisal process before making an offer—especially an aggressive offer—can help you prepare for what might happen if the valuation doesn't match the price you've agreed to pay.
The appraisal is only one part of a real estate transaction, but when financing is involved, it can have a major influence on whether that transaction ultimately reaches the closing table.
