“Appraisals: 101” crash-course

The final piece of a mortgage application that a bank is interested in reviewing is the property itself. After all, if a borrower fails to make their monthly payments then the bank will take the house back and sell it in order to recoup the money that they loaned against it.

The value of a home will generally be determined by a professional appraiser’s appraisal report.  There are multiple methodologies for determining the value of a home. The two that show up in an appraisal report are the “cost approach” and the “sales comparison approach”.

The “cost approach” determines the value of a home based on the value to rebuild or replicate the property from scratch. This analysis will take into consideration the value of the land that the home is built on and add the cost to rebuild the improvements based on the square footage and amenities (i.e. basements, garages, etc.). The “cost approach” is less relevant to a bank because they never intend on rebuilding the property. However, they may review this in determining if the homeowner’s insurance policy provides enough coverage.

The “sales comparison approach” is the most relevant to lenders in determining the value of the collateral property. With this approach an appraiser will find what they consider to be the 3-6 most comparable properties that have sold near (usually within 1 mile) the subject property within the past few months.

The appraiser will then make adjustments to the value of the subject property by comparing various features of the home. Among the factors that can impact the adjustments are square footage, view, quality of construction, built in amenities/ upgrades, number of bedroom and bathrooms, heating cooling systems, etc.

The value as determined by the sales analysis approach is the most important in determining the value for the home in the lender’s perspective.