What Happens When Appraisal Values Come up Short?
For the past two years, appraisal valuations have rarely fallen short. Instead, we routinely saw appraisals coming back at the purchase price—and often higher—due to the national pandemic-induced frenzy for real estate.
Since February of this year, the music has stopped playing in many markets across the nation, and the real estate marketplace is balancing out. Our Realtor colleagues report far more listings than before, meaning the supply problem we thought would never go away is suddenly less of a concern.
Raging inflation and rapidly rising interest rates have cooled off the market.
Now, there are situations where homes occasionally appraise for less than their agreed purchase price.
Does a low appraisal value kill a deal?
No, not necessarily. If the only thing off in the appraisal report is the price, the buyer just has to come up with additional funds to make up the shortfall and they’re good to go.
However, there’s also the possibility the appraisal raises other concerns, such as:
- Identifying structural or mould issues.
- There is a short economic life of the property.
- The house is in below-average condition.
These and other such issues can kill your mortgage lender’s interest in your transaction, regardless of the valuation of the property.
What happens if your offer is firm, with no condition of financing?
You are obligated to complete your purchase at the agreed price. If the appraisal comes up light, but the property is otherwise acceptable, your lender is likely still prepared to offer you a mortgage. However, it may not be as big a mortgage as you hoped.
Suppose you agree to buy firm for $1,100,000. You are willing to put up 20%, or $220,000.
But, the property appraises at only $1,000,000.
Your lender will offer you a mortgage of $800,000, which is 80% of the appraised value.
You will have to come up with $300,000 to fulfill the purchase price of $1.1 million.
That’s an extra $80,000 you hopefully have at hand.
Will your pre-approval protect you if the appraisal is low?
Your pre-approval is not a guarantee you will receive the amount specified in your pre-approval certificate. Instead, it is an indication you may qualify for mortgage financing up to a certain amount, assuming everything else checks out.
The pre-approval is about you and your personal covenant. It has no property-specific information, which is always the unknown when looking to purchase.
In other words, your pre-approval has nothing to do with your appraisal coming in low.
What happens if your purchase is a high-ratio transaction?
Most of the time, a high-ratio mortgage (default-insured purchase) is approved without a formal appraisal. However, it can happen that the insurer (Canada Guaranty, Sagen or CMHC) requires an appraisal prior to issuing a commitment.
Your broker will not receive a copy of this appraisal, but they will be told if the valuation came in light or just right, and will share this verbal appraisal estimate with you.
If your offer to purchase included a financing clause, then a light appraisal will give you the option to either reduce your offer price, walk away from the purchase, or make up the difference from your own funds.
Can you debate the value with the appraiser?
No one really enjoys being second-guessed; it’s human nature. Appraisers do this for a living and they are licensed, trained professionals. They know what they are doing. More often than not, they will stick to their guns.
That said, if spoken to with respect and understanding, I have occasionally seen some movement in their opinion of value. I don’t think you should count on this, though.
As mortgage brokers, we can sometimes ask the appraiser not to send the report to the lender until we’ve had a chance to review it. This might lead to a discussion of the value, or may even result in asking a second appraisal company for their view on value.
Can you have a condition of appraisal clause?
Leaving one solitary condition like “subject to appraisal” might be the right way to go in this market. It tells the seller you are not worried about financing (getting a mortgage), which, coupled with your husky deposit and agreeable closing date, is a pretty respectable offer.
It also gives you an out, since withdrawing an offer following an appraisal should not cause you a problem, in my opinion.
It’s now time to exercise some caution when buying real estate. Things are changing quickly. Make sure you have a strategy in place so that if your appraisal comes in low, this would not devastate your personal finances or kill your accepted offer to purchase.
Don’t be shy about inserting a couple of conditions in your offer to purchase, just like we used to when the market was balanced and not skewed in favour of sellers. For the first time in years, you may have the time to make calculated decisions.
There is no predicting if this is just a speed bump till things settle down or if we are headed into a long-term correction. For some, this environment spells opportunity, and for others, it spells caution.