Buying a home: Should you skip the home appraisal?

Peter Miller
The Mortgage Reports contributor

In this article:

A home appraisal is a big deal in real estate. It’s a cost for buyers and often a source of worry for sellers and brokers. Now, the government is considering a new rule that will make appraisals far less common for properties selling for $400,000 or less. Costs may fall by hundreds of dollars for many borrowers, but is this a good deal for purchasers?

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Why valuation options are changing

For some time, Fannie Mae and Freddie Mac have been looking at potential home appraisal options. Their logic is that they have so much data from past loans that they have a very good sense of individual home prices. Fannie Mae, for example, has 31 million appraisal reports in its system.

Related: My home didn’t appraise for the purchase price (What happens now?)

Freddie Mac says it’s “using big data and advanced analytics” so that borrowers can have the “option to underwrite certain loans without a traditional appraisal.”

The $400,000 home appraisal benchmark

In late November 2018, several government regulators proposed a new rule which would allow lenders to substitute “evaluations” for appraisals in certain cases, but only with borrower approval. If your lender gives the okay, the property can be valued with an “automated valuation model” or AVM instead of a home appraisal.

Related: Help! I need to appeal my home appraisal

Say yes to the AVM, and you can save money and speed the transaction. However, without someone physically going through the property will you get the right value? Might you overpay?

Appraisal issues

According to the National Association of Realtors (NAR), the three big reasons for closing delays were obtaining financing (37 percent), home inspection and environmental concerns (18 percent), and appraisal issues (17 percent).

Problems can arise when the appraised value is less than the sale price. The seller and buyer will have to change the terms of their agreement. The buyer might put in more cash or the seller might reduce the price. They might compromise. If neither party will budge, the sale can fall through.

The no-appraisal option

We now live in an era of big data and artificial intelligence. Combine the two and you can create an automated valuation model. You can also create a controversy. Are AVM results so good that you don’t need appraisals?

Related: What’s my house worth? 4 ways to estimate your property value

One example of an AVM is the home price estimates published on many real estate sites. Here’s another. If you’ve financed or refinanced a home in the last few years, it’s possible that the property was not only appraised but that the lender also obtained a “value report.”

Such reports look at the appraisal and compare its results with valuations for nearby properties.

How appraisals impact your mortgage

Mortgages and appraisals go together like salt and pepper. You can see the importance of appraisals in several ways.

First, while buyers and sellers may agree on a sale price, that’s not enough for lenders. They want an estimate of value from an independent professional. The result is that appraisers are paid for the act of valuing a property, not for finding a particular value.

Related: Do I need a home appraisal to refinance my mortgage?

Second, once they have both a sale price and an appraised value, lenders will make loans based on whichever value is lower. Lenders take this conservative approach to make sure that buyers have enough of their own funds invested for the loan program.

For example, some Fannie Mae loans have a 3 percent down payment requirement. The fact that the buyer has a 3 percent investment makes the loan safer for the lender. But if a $97,000 property appraised for $100,000, basing the loan amount on the higher value would have the buyer putting zero down. This adds risk to the loan.

Do we really need appraisals?

There’s no doubt that a professional appraisal is the valuation gold standard. That said, HUD recently disclosed that 37 percent of 134,000 FHA-insured reverse mortgage loans it studied were at least 3 percent too high.

The HUD data raises a bunch of questions. Have appraisals worked better or worse with FHA-backed forward mortgages? Is 3 percent a big deal? Is there a more accurate valuation approach?

Appraisals also have pros and cons for borrowers. On one side, borrowers want appraisals to prevent overpaying for a property. In effect, appraisals are an important form of consumer protection. On the other, standard appraisals cost hundreds of dollars at a time when there are a lot of expenses for borrowers, and money can be tight.

If the proposed rule passes – and if given the chance by your lender – should you skip the use of an appraisal? It’s up to you; just realize that there are both pros and cons regardless of which option you choose.

Verify your new rate (Jul 21st, 2019)