How does a home appraisal work?

Demystifying an important step in the buying process. (iStock)

Appraisals caught a bad reputation in the aftermath of the 2008 mortgage crisis. In order to circumvent lenders handing out money on over-valued homes, most banks now require home appraisals as part of almost every mortgage transaction -- both purchase and refinances.

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A home appraisal is when a certified appraiser comes to assess the home and estimate the fair market value — but there's a bit more to it than that. Here's what you need to know.

How does a home appraisal work?

Usually, an appraisal is ordered by a lender only when underwriting a new mortgage loan. Sometimes a homeowner may conduct a “pre-appraisal” themselves, in instances when they want to do a for sale by owner transaction or want more education about a home’s fair market value. This can be especially helpful for homeowners after extensive repairs and renovations, or if it has been a few years since they’ve encountered the real estate market in their area.

To see what lenders in your area require, visit Credible to shop rates, qualification criteria, and loan terms in one place.

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Why is it needed?

Since most banks allow buyers to use the home they are buying as collateral for the mortgage loan, they want to ensure they only hand over money for how much the asset is truly worth. Only allowing borrowers to obtain money for the appraised purchase price is a way to hedge against real estate overinflation or a borrower owing more on the loan than the home is worth.

Are you in need of a home loan? Credible can tell you step-by-step everything you'll need to provide. Plus, you don't have to leave the comfort of your home to submit your application.

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What does an appraisal cover?

An appraisal is substantially different from a home inspection. An inspection is for the home buyer; to educate the borrower on what they’re buying. During an inspection, the inspector is looking for defects within the home and reports on the status and condition of all the major systems such as the structure, electrical, plumbing, and HVAC.

Also, inspections aren’t mandatory or required by the lender, they’re just highly recommended.

An appraisal is for the lender and almost certainly required if you’re using a mortgage loan to purchase a piece of real estate. While an appraiser may take into consideration some items that would come up during the course of an inspection, an appraiser’s main job is to assign a dollar value to the home.

The appraiser isn’t so much concerned with defects or flaws in the home, although they do take this into consideration. Instead, they will look at the home’s value in relation to the area, as well as how the property compares to similar homes nearby in terms of size, upgrades, and condition.

Check out Credible to determine what kind of mortgage rates you'd qualify for today.

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How much does a home appraisal cost?

According to estimates from Home Advisor, an appraisal can run anywhere from $300-$400. Although a lender will require an appraisal, the buyer/borrower is the one who pays for it, so buyers should consider this expense when budgeting for a home purchase and closing costs.

Unfortunately, there isn’t a standard fee for an appraisal and the price varies by the size of the home, the location, and the amount of time it will take for the appraiser to gather data.

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Pros and cons of a home appraisal

Pros

  • Knowledge is power: The biggest benefit of having an appraisal is the knowledge of the true fair market value of your home. Having this knowledge at hand informs a variety of decisions like when to list, how much you can potentially make on the sale, and the amount of equity a current homeowner has in the home.
  • Supporting documentation for a listing price: A pre-appraisal can provide documentation in support of your asking price, especially if you’re asking for more than what most homes in your area sell for.

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Cons

  • Low appraisal: Nothing throws a wrench into a real estate transaction quite like a low appraisal. In the event a property appraises for lower than the agreed-upon sales price, the buyer and seller must renegotiate. The seller can either lower the list price or ask the buyer to bring the difference between the appraisal and the sales price in cash.
  • More time between contract and closing: In addition to due diligence and underwriting, an appraisal is one more step in a time-sensitive process.

It is also worth noting that since the onset of the COVID-19 pandemic, some lenders are offering appraisal waivers. Waiving the appraisal requirement means fewer individuals in a home, one less step of the mortgage underwriting process, and buyer and seller certainty the deal will close at the agreed-upon terms. Buyers can request an appraisal waiver with their lender, although typically only conventional loans qualify.

A good lender will walk borrowers through the mortgage loan process, including what to expect from an appraisal. To shop mortgage options (and today’s historically low-interest rates) in one place, visit Credible.

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