How Do Appraisals Really Work?

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By Clever Real Estate Updated April 11, 2024


How the appraisal process works | Prepare for an appraisal | When the appraisal comes in | FAQs

Understanding how home appraisals work can improve the home-purchase and refinance process for both home buyers and sellers.

An informed buyer or refinancer can protect themselves from potentially losing a great deal of money. An informed seller can protect their sale and improve their appraisal by preparing properly.

🔑 Key takeaways:

  • Appraisals are required for nearly all home purchases and refinances.
  • A low appraisal can jeopardize a buyer’s funding and the sale overall.
  • Appraisal-specific contingencies are the best way for buyers and sellers to protect themselves from the impact of low appraisals.
  • Racial discrimination can lead to lower appraisals and is a persistent problem.

Read on to go over the nuts and bolts of what an appraisal is, or jump directly to:

What is an appraisal?

A property appraisal provides a professional estimation of a home's value, most often based on a physical inspection and comparable home sales. It's performed by a licensed appraiser and used by the lender to determine the value of the home.

What kinds of appraisals are there?

Four common types of appraisals are a full appraisal, hybrid, desktop, and drive-by. The full appraisal is both the most common and the most comprehensive.

When should I get an appraisal?

Your lender will require an appraisal during the process of granting a mortgage. It takes place after your offer on the home has been accepted. You'll also need to get one when refinancing your home.

Sellers can get a pre-listing appraisal, but this generally won’t be used by the buyer’s lender.

When don’t I need an appraisal?

An appraisal won't be required during the home-buying process if you are paying all cash.

If you're refinancing via certain government programs, like a streamline Federal Housing Administration refinance or a Department of Veterans Affairs Interest Rate Reduction Refinance Loan, you may also not need an appraisal.

How long does an appraisal take?

An appraisal can take up to two weeks. During this time, the appraiser will research comparable sales, evaluate the home’s characteristics, and write their report.

Understanding how the appraisal process works

Understanding how the appraisal process works is necessary before learning how to properly prepare yourself. In this section, we’ll break down what you need to know about every step of the way.

Who performs the appraisal?

A licensed appraiser hired by the lender performs the appraisal. After a buyer’s offer is accepted, including whichever contingencies were agreed to, the lender will schedule an appraisal.

Appraisers are supposed to be neutral third-parties in the hopes that everyone involved gets treated fairly. This is often the case. However, there's a long history of racial discrimination in appraisals, which often leads to lower appraisals than would be fair.

What does the appraiser do?

Appraisers evaluate homes with a combination of on-site evaluation and off-site research. They use this information to come up with a value for a home.

While they're at the home, an appraiser will: While they're working of site, an appraiser will
Take photos of the interior and exterior Put together a list of at least three comparable properties ("comps") sold recently, usually within the last 90 days. These homes will have similar features to the home they’re appraising.
Measure the home's square footage Compare the comps to the features and conditions of the property in question
Note condition of the HVAC system Determine their best analysis about the property’s value
Note upgrades, especially energy efficient upgrades and improvements to the kitchen and bathrooms Write a report, which can take up to two weeks
Document areas that need repairs Submit the final report to the lender
Evaluate material and conditions of floors and other surface
Document outdoor amenities
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Using this information, the appraiser will arrive at what they believe to be the home’s value and submit that information in a report to the lender.

What's included in the appraisal report?

The report the appraiser produces includes:

  • The appraiser's evaluation of the home’s characteristics
  • A street map showing the appraised property and comparable sales
  • An explanation of how the square footage was calculated
  • Photos of the home’s front, back, and street view
  • Front exterior photos of each comparable property
  • Other relevant information, such as market sales, data, public land records, and public tax records

What happens when the appraiser submits their report?

The appraiser submits their report to the lender. Appraisals primarily serve the lenders, who use them to determine whether they should loan the buyer the agreed upon amount of money.

The buyer will also receive a copy of the appraisal.

How to prepare for an appraisal

Both buyers and sellers want to avoid a low appraisal, which potentially jeopardizes the buyer’s financing, but there's a limited amount either party can do to impact the appraisal itself. Still, both parties can mitigate the risk.

Appraisal prep for buyers

Appraisal contingency in contract

All buyers can do to prepare for an appraisal is to negotiate an appraisal contingency into their contract.

Crucially, the appraisal contingency needs to be in the contract when the buyer signs the offer. It cannot be added in once the appraisal comes in low.

An appraisal contingency allows the buyer to exit the sale with their earnest money if the appraisal comes in too low.

An appraisal contingency is useful for buyers even if their contract includes a financing contingency. Financing contingencies only allow the buyer to exit the sale if their financing falls through. A low appraisal often leads to a reduced financing amount, but because the buyer still receives funding the financing contingency doesn't protect them.

However, if your lender is still willing to fund a portion of the original amount, buyer’s without appraisal contingencies may find themselves responsible for additional out-of-pocket money or be at risk of losing their earnest money.

For a sense of what an appraisal contingency would look like, here’s an example California Residential Purchase and Sale Agreement:

appraisal contingency example

Appraisal prep for sellers

Appraisal gap coverage in contract

Appraisal gap coverage, or an appraisal gap clause, states that the buyer will pay a certain amount of money on top of their agreed upon down payment in the event that a low appraisal results in their funding falling short.

This needs to be included in the original contract between the buyer and the seller if either party wants it codified.

In the event of a low appraisal, sellers can still attempt to negotiate that a buyer pay more on top of their down payment to cover the space between the sale price and the total of their loan and down payment.

This benefits sellers because it makes the sale more likely to go through without having to lower the price or negotiate after a low appraisal.

In competitive markets, buyers may consider including appraisal gap coverage in their offer to make it more attractive. Here’s how it works:

  • The contracted sale price is $200,000.
  • The buyer is funding the purchase with a $40,000 down payment and $160,000 loan.
  • The appraisal comes in at $190,000.
  • Due to the appraised value, the maximum the buyer’s lender will provide given their agreed upon loan-to-value ratio is $152,000, meaning they only have $192,000 for the purchase.

If the contract included appraisal gap coverage up to $10,000, the buyer would put an additional $8,000 down to fund the purchase.

Present documentation that proves the home’s value

Sellers can improve their odds of getting a higher appraisal by presenting the appraiser with evidence that aligns with the contract price. The National Association of Realtors recommends providing documents like:

  • Proof of significant changes a seller has made to things like their roof and HVAC system. This can help to demonstrate value on the home that might not otherwise be clear.
  • Flattering comps. Appraisers can choose from a wide range of comparable sales, so experts recommend providing them with comps that are in line with the sale prices to help to confirm what the home is worth.

Make small improvements to the home

Repairs a seller might make to raise the value of the home before they put it on the market are likely to raise the appraised value as well.

Sellers can focus on things related to safety. For instance, fixing damaged hand railings, repairing damaged stairs, and securing water heaters tend to have a big impact. Renovated bathrooms and kitchens can also raise an appraisal.

» READ MORE: How to Get the Highest Appraisal on your House

What to do when the appraisal comes in

Most of the time, the appraisal comes in and everything is fine. But issues that could jeopardize the sale do come up and knowing what to do in those instances can help to prevent the sale from falling through.

When the appraisal is right on the contract price

Neither party has to do anything. The sale can proceed without an issue.

When the appraisal is above the contract price

Neither party has to do anything. Sellers can't renegotiate the contracted sale price.

When the appraisal is below the sale price

Low appraisals can reduce the amount of money a lender will provide a buyer, which can potentially jeopardize a sale. Preperation and work from both buyers and sellers can reduce the likelihood that the sale will fall through.

Low appraisals are problematic because when buyers sign with lenders, there's an agreed upon loan-to-value ratio (LTV). If, for example, the LTV is 80%, that means the lender is willing to pay for a loan of up to 80% of the property’s value.

If an appraised value is low enough to create a gap between the down payment plus loan amount and the sale price, the buyer and seller will then have to work out a new deal if they want to complete the sale.

Here's what different appraised values would mean for a buyer of a $300,000 home.

Sale price Appraised value Down payment (20%) Maximum loan at 80% loan-to-value ratio Total funding Gap that needs to be covered
$300,000 $300,000 $60,000 $240,000 $300,000 $0
$300,000 $294,000 $60,000 $235,200 $295,200 $4,800
$300,000 $285,000 $60,000 $228,000 $288,000 $12,000
$300,000 $270,000 $60,000 $216,000 $276,000 $24,000
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According to a Freddie Mac study from 2021, 8% of home sales had appraisals come in lower than the contract price. So it's unlikely an appraisal will be low, but it’s important to be prepared.

If the appraisal does come in low, you have three options: negotiate new terms for the sale, appeal the appraisal, and back out of the sale.

Negotiate a new price

The buyer and seller renegotiate the deal to a price that works for them with the new maximum loan number.

The seller will want the buyer to cover the gap by putting more money down and the buyer will want the seller to cover the gap by reducing the price. A compromise that involves a little bit of both will most likely be the easiest solution.

According to a 2012 Fannie Mae study, in sales where an appraisal comes in 2% lower or more than the contract price:

  • 51% sold through at a lower price.
  • 15% sold through at the contract price.
  • 32% weren't sold within 90 days of the contract date.

Appeal the appraisal

You can challenge an appraisal if the appraiser makes a provable error. Even if a competing appraiser reports back with a higher number, that report will only be relevant to the lender if it proves that the other appraiser missed something or made a factual error.

Racial discrimination has long impacted appraisals and the issues persists to this day. According to a study performed by Freddie Mac, using 2010 United States Census Bureau data, majority-Black and majority-Latino areas had much higher instances of appraisals coming in below the contract price than majority-white areas.

Tracts where the population is more than 50% Black or 50% Latino had appraisal values come in below the contract price 12.5% and 15.4% of the time, respectively. In areas more than 50% white, this happened 7.4% of the time.

If you are concerned racial discrimination led to a low appraisal, you can file a complaint with the Department of Housing and Urban Development.

Back out of the sale

If the two parties can’t come to an agreement and the appraisal can’t be appealed, it may be prudent to back out of the sale. This outcome is a huge disappointment for everyone, but for buyers it may be a much better option than paying more money out of pocket to purchase an asset an expert has determined isn't worth the price.

If, as the buyer, you have an appraisal contingency, you're financially protected. If the issues with your financing meet the criteria set out in your financing contingency, you will also be financially protected.

If neither an appraisal contingency or a financial contingency are included or met, you risk losing your earnest money. How much money you'll lose by backing out of the sale will be unique to each situation, and will impact how prudent it is to take this path.

👋 Next steps: Talk to an expert

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Why do I need an appraisal?

Lenders require an appraisal because they need to assess the value of the home because it's the collateral for the loan they are offering the buyer. If the home isn't determined to be worth enough, it won’t be sufficient collateral for the loan

What can you do if your appraisal comes in too low?

If your appraisal comes back low enough to jeopardize the purchase, the three options you have are to appeal the appraisal, renegotiate the sale, or back out of the sale.

The most likely outcome is that the buyer and seller come to a new agreement at a reduced price.

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