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Appraisal glitches can stall, derail home sales

My nephew bought his first house not long ago, but only after the deal was almost scuttled by a faulty appraisal.

The appraiser from the Veterans Administration didn't notice that an addition had been built onto the house in Oak Harbor, Ohio. He appraised the home's value based on the original square footage listed in the county records. The appraisal report concluded that the house was worth less than the price that the seller and my nephew, J.R. Majewski, had informally agreed upon.

J.R.'s experience shows that an appraisal for less than the price of the house doesn't have to derail a sale, although it can.

In J.R.'s highly unusual case, the faulty appraisal aided him. The owners were selling without a real estate agent and were desperate to close the sale fast because they were having another house built and needed the cash. J.R. was willing to pay $110,000, but his banker told him not to sign a purchase agreement until the appraisal came back.

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When the appraised value came in at $97,300, the sellers almost balked. Their harshly worded phone call to the appraiser made things worse -- the appraiser refused to come back out. Instead of putting up with a three- to four-week delay for another appraisal, or searching for another willing buyer, they sold the house in Oak Harbor, Ohio, to J.R. and his wife, Nikki, for $99,300 -- in effect, a $10,700 discount. J.R. and Nikki borrowed $97,300 through a VA loan and paid the $2,000 extra via gift money from family.

"The VA appraiser, as much of a jerk as he was, actually helped me," J.R. says.

Appraisers' role
When you borrow money to buy a house, the lender requires an appraisal -- a neutral expert's estimation of the home's fair market value. The appraiser considers many factors, including the prices of comparable homes that have been sold recently as well as the condition, size and amenities of the property being appraised.

The lender requires an appraisal because it would be bad business to unwittingly lend more than the house is worth. In the vast majority of cases, everything is fine: The house is appraised at or above the sale price and the loan goes through.

Occasionally, the appraisal is for less than the home's selling price. What happens next depends upon how much of a down payment the buyer plans to make.

If the buyer is going to make a sizable down payment, the lender might not care about the low appraisal. For example, if the sale price is $200,000, the appraisal comes in at $20,000 less than that, and the buyer is making a $100,000 down payment, the bank will let it slide. "The risk is still low enough for the bank to close on the transaction," says James Mason, sales director for online lender MortgageIT.

Time's a factor
Why not dot the i's and cross the t's by getting another appraisal? "Because everything takes time," including appraisals, says Ellen Bitton, president of New York-based Park Avenue Mortgage. As a typical real-estate sales contract states, time is of the essence.

The process works differently when the down payment is small or nonexistent. If someone has $3,000 for a down payment on a $100,000 house, and the appraised value comes in at $95,000, that loan will not be approved. The bank won't lend $97,000 for a house that an appraiser says is worth less than that, especially if the buyer can scarcely scrape up a down payment.

"In the case where the appraiser has missed something, the bank usually goes back to the appraisal company to have them reevaluate," Mason says. Perhaps it's an obvious error such as not noticing that an addition was built onto the house. More likely, the problem stems from not finding the right "comps," or "comparables" -- prices of similar, nearby houses that were sold within the last six months.

When is a comp not a comp?
In slow markets and rural areas, the appraiser might have trouble finding comps, so the lender might ask the appraiser to look farther away for examples of comparable homes, or to search farther back in time -- up to 18 months ago instead of six months.

In very hot markets, the appraiser might be looking at recent sales data that already are out of date because prices are rising so fast. This happens because appraisers rely on county records, which usually take two or more weeks to be updated. In some super-hot areas on the coasts, home values can rise more than 20 percent a year, meaning that sales prices are out of date after just a few weeks.

When the appraiser won't budge, or time is limited, the buyer and seller have three options: Reduce the price, make a bigger down payment, or nix the deal.

"It usually works out," says Diane Saatchi, a senior vice president in Corcoran's East Hampton, N.Y. office. It's rare for the agreed-upon price to truly be too high, she says, "because, by definition, if somebody's willing to pay it, that's what it's worth."

-- Updated: April 6, 2005


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