When it comes to buying or selling a home, one of the most important parts of the process is also the one that most people don’t spend too much time thinking about: the appraisal.
An appraisal happens when an independent third-party tries to accurately assess exactly how much money a home is actually worth. These appraisals are typically conducted by licensed and certified experts and are based on, among other things, similar homes in the same neighborhood and other factors pertaining to the market. A visual inspection of the property’s current condition is also usually conducted, all in an effort to come up with the most accurate price possible.
Appraisals are useful in a variety of situations – including just before you sell your home, if you’re thinking about refinancing your home or if you’re planning on getting something like a home equity loan. The process is not perfect, however – which is where issues like appraisal creep begin to come into play.
It’s important to understand that appraisals are ultimately designed to protect buyers from significantly overpaying for the home in question. That’s why appraisal creep is such an issue for everyone – by artificially inflating the fair market value of a home, people end up spending more money than they should on a house that isn’t worth nearly as much as they think it is.
One recent study illustrated just what a significant issue this has become. Experts looked at more than 8,500 houses that Fannie Mae had foreclosed upon between 2012 and 2015. Each house had at least two appraisals done roughly six months apart. The first appraisal was conducted immediately after Fannie Mae took over ownership of the property, and the second appraisal was done after another buyer went under contract for the home.
Keep in mind that in these particular situations, absolutely no modifications or repairs were made to the properties in question during those two periods of time. Therefore, the biggest difference wasn’t the homes at all. The second appraisals almost uniformly came in significantly higher than the first for what is ultimately a simple reason: the appraisers were made aware of the sales price that was listed in the then-current contract.
Essentially, those appraisers knew what target they were trying to hit so they did – regardless of what it required them to do to get there. That same study revealed that the second appraisals tended to come up at roughly 4% higher than the ones that were originally conducted soon after Fannie Mae took ownership of the homes.
Part of the discrepancy here comes by way of how the appraisal process works to begin with. When someone talks about the fair market value of a house, they’re not really talking about a specific dollar amount. A lot can impact this including aforementioned modifications to the home, the current market conditions and even things like the quality of nearby school districts that may fluctuate in a given year.
With an appraisal, however, someone does have to come up with a precise dollar amount due to the way lending works. A financial institution is never going to provide someone with a mortgage that is more than the value of the home as they would almost immediately be underwater. Therefore, a definitive dollar value for the home has to be agreed upon no matter what.
So from that perspective, one part of the process is naturally at odds with the other – which is where issues like appraisal creep begin to come into play.
Appraisal creep also tends to have something of a ripple effect throughout the surrounding community, too.
Whenever a home sells in a neighborhood, it quickly becomes a “comp” – otherwise known as a comparable property. This means that other real estate agents, lenders and appraisers will use that sale price in order to determine the fair market value of other homes in the area that are about to sell.
If one property in an area has an appraisal that is an average of 4% higher than it should be as per the study above, that information will artificially influence the next round of home sales in the area. Soon, house prices will begin creeping up for a new real reason – potentially causing the market to appear much “hotter” than it actually is.
Essentially, it’s an issue that is baked into the real estate industry in its very DNA – and it’s one that many people have tried to correct over the years, to no avail.
If you’d like to find out more information about appraisal creep when it comes to real estate, or if you’d just like to speak to someone about your own needs in a bit more detail, please don’t hesitate to contact AmeriMac today.