When you sit down with a loan officer to fill out a mortgage application—maybe you’re buying a home; maybe you’re refinancing your mortgage, taking advantage of today’s historically low interest rates—you learn soon enough that loan underwriters demand exactitude when assessing the creditworthiness of prospective borrowers.
To get a residential mortgage, you’ll have to tell the bank exactly how much money you make, most likely supplying the lending institution with your two most recent pay stubs. The bank may also want copies of your last few years of tax returns. Having accounted to the penny for your income, the bank then will need to know all about your expenses, particularly your debts. With as much mathematical precision as possible, your banker will add up your debts, calculate your monthly minimum payments—the minimum monthly cost of servicing your debts—and work to establish your debt to income ratio.
Even then, assuming that the debt to income ratio doesn’t blow you out of the water, the bank will want to know something about your payment history: do you consistently make your payments on time or are you chronically late? Have you recently failed to make payments on any or all of your outstanding debts? Have you defaulted on any loans? Have you recently filed for bankruptcy? To review all the available detail on your credit history, the bank will order a credit report, using your credit score to help determine whether or not to give you a loan and at what specific terms.
For borrowers who successfully navigate the exacting application process and emerge with conditional approval for a loan, it’s hardly time to begin the celebration. A very important step in the loan process remains: the bank will order an appraisal of the property against which you hope to borrow. And whether this is your first mortgage on your first home or the umpteenth refinance of an investment property you’ve owned for decades, the bank is interested in one thing above all else: how much is your collateral property worth?
Having been through the first part of the process—accounting for your income and debt—you may assume that the appraisal of your property will be as open-and-shut as adding up what you make and what you owe was. Think again. While property appraisal undoubtedly has lots of rigorous scientific methodology to it, it is also, in some sense, an art. Unlike the process to determine a borrower’s creditworthiness, which is based largely on events that have already transpired and can be accurately quantified, the process of appraisal looks to the future, attempting to predict how much a property would likely sell for on the day it’s appraised.
The banks, of course, know full well that an appraisal is a prediction. Indeed, with extremely high-value homes, where a few percentage points high or low can translate to hundreds of thousands, maybe even millions of dollars, banks routinely order more than one appraisal. If the two appraisals come back showing a sizeable disagreement between them, the bank will likely order yet another. (According to local appraisers interviewed for this article, banks are generally looking for two appraisals stating values within 5 percent of each other before feeling comfortable.)
For some borrowers in some real estate markets, the appraisal may be largely academic. If your home is worth, say, $200,000 and you’re only seeking a mortgage of $50,000, the loan to value ratio does not represent a huge risk to the bank, depending on your creditworthiness. But for many borrowers, particularly those refinancing in the current real estate market—with low bank interest rates being offered at a time when many property values are still lower than they were just a few years ago—the appraisal may represent the difference between a sweet deal and no deal at all.
For example, if a homeowner seeing to refinance a 15-year home mortgage with cash out to consolidate and pay down debt, the appraisal will have to come in high enough, in most cases, to keep the loan to value ratio at or below 80 percent. So for a borrower seeking a total mortgage of, say, $80,000, the appraisal of the collateral property will have come back at $100,000 or greater.
Your job: monitor the appraisal
It is the banks, for the most part, that order appraisals. In effect, the bank is looking for an independent appraisal—one not influenced by any party to the deal. But while borrowers don’t have the responsibility, or the opportunity, to pick the appraisers, there are a few things you can do to make sure the appraisal on your home is done properly, based on an accurate view of the property, its location and the market in which it is being appraised.
“I know that a lot of research goes into appraisals and the appraisers do try to be fair, do a good job and not blow up deals,” said Craig Della Penna, a Northampton-based real estate agent who specializes in homes near area rail trails. Over the years, Della Penna said, there have only been a few instances in which he found the appraisals lacking. “One stated that the overall market was declining in that community (when it was not) and [in another disappointing appraisal] the condition of the property was stated as being ‘average,'” Della Penna said.
A potential borrower can challenge an appraisal, Della Penna said. “Challenging an appraisal is most successful when you can demonstrate that the appraiser isn’t very familiar with [the specific] market locale,” he said.
Though the banks order the appraisal, regulations require that borrowers receive a copy. It’s important that borrowers review the appraisal to make sure that the appraiser based the finding of value on accurate information, i.e. the correct number of bathrooms, total square footage and other features.
Beware the drive-by
While most banks want to work with an experienced appraiser who conducts a full interior and exterior inspection of the property, there are still occasions when a bank will be satisfied with an exterior-only inspection. Known also as “drive-by” appraisals, exterior-only inspections are used most frequently when a bank perceives its risk to be minimal. In a booming real estate market, for example, banks might be more prone to accept an exterior-only inspection, particularly in cases in which the borrower is a good credit risk and isn’t seeking a high loan to value deal. Still, many real estate agents view the drive-by appraisal with suspicion.
“I don’t understand how drive-by appraisals in this market can pass muster,” said Amy Heflin, an agent with Keller Williams Realty in downtown Northampton. “When I get wind of a drive-by appraisal, I think, what about a wet basement versus a dry, finished basement? What about new hardwood floors versus linoleum? These things matter.”
Heflin advises her clients to monitor the appraisal process carefully. “You can say to your banker that, when it comes to the appraisal, you’d like to have a locally licensed appraiser with knowledge of the market to go into—that’s the key, to go into—the house.”
Della Penna agrees. “Experience in that locale is key. The old adage that ‘every market is local’ is true. You cannot do drive-by appraisals and be accurate, nor can you be from 100 miles away and be in the know about a neighborhood around here.”
Wanted: experienced appraiser
“If we’re doing the job correctly,” says appraiser Tom Dietschler, owner of Bay West Appraisers in Agawam, “we aren’t influenced by any party in the deal: not by the lender, the borrower, the broker, the lawyer. We’re there to give an impartial and accurate estimate of the value of the property.”
Dietschler has spent more than two decades appraising property in Western Mass., and Connecticut. While he has generally positive things to say about his profession and the caliber of appraisers he runs into—”I like to look at it as, the glass is half full,” he said, with a chuckle—the quality of an appraisal, he points out, is usually a reflection of the experience level of the appraiser. “Most people in the business are professional,” Dietschler said, “but it’s all to the degree of their training.” Quite often, he continued, experienced appraisers have a more accurate and nuanced view of the “markets and submarkets” where they work.
“It’s about knowing your competency level,” Dietschler said. “I’ve turned down requests to appraise property on Cape Cod, for example. It’s beyond my areas of experience and expertise.” An appraiser, he said, needs to be aware of anomalies in particular markets.
Take Springfield. While the general market has declined, the city has certain submarkets—Dietschler pointed to the Sixteen Acres neighborhood as an example—that “are very strong.” An experienced appraiser will know about variations in value on a street-by-street basis.
In the Valley, particularly in more rural communities, appraisers often see one-of-a-kind property that can’t easily be compared to other recently sold real estate. Without adequate numbers of “comps” close by, Dietschler said, an appraiser must begin to look at recent sales in similar but not necessarily neighboring towns.
“Why do we do that with certain homes? Let’s say you have an antique farmhouse on excessive acreage. There’s nothing else in town like it, no recent comps. So we look outside the immediate market, just as a potential buyer would. Somebody in the market for an antique farmhouse with lots of land isn’t likely to confine their search to a single town, so neither do we,” Dietschler said.
Dietschler said that drive-by inspections are rarely used except in cases where the bank sees minimal risk.
“It all has to do with risk,” he said. “Say we have a $400,000 home—it’s assessed for tax purposes at $400,000—and there’s no mortgage on it now and the owner is only borrowing $100,000. If they defaulted, the bank would be more than repaid. It’s possible that [the bank] would only order an exterior inspection, though these days, even with no risk, they usually want to document the file with a full inspection.”
In nearly every case, Dietschler added, “exterior-only inspections result in lower values than full inspections.”
Heflin sees the work of highly trained and experienced appraisers not only as she works with clients to buy and sell property, but well after the deals have closed. “I get four or five calls per month from appraisers doing research on recent closings to access comps for a property they’re appraising,” she said. “Instead of going straight from the public records, they’re using me as a set of eyes, asking me about what’s been updated, what condition the interior is in, whether the systems are in good working order.”
Of first impressions and freshly baked cookies
While you don’t have much control over the appraisal process, Heflin and Della Penna recommend that borrowers approach appraisals in much the same way as they would an open house for potential buyers.
“It’s the same strategy as selling your house,” Della Penna said. “Get your house clean, presentable, trim bushes, get the winter sand off the driveway, get rid of clutter and unnecessary things on horizontal surfaces. Do updates as your budget dictates. And clean the basement!”
“To get the highest value possible,” Heflin said, “make sure all the working parts—roofs, windows, heating systems, plumbing—are in good working order and that your home is ‘hotel clean,’ particularly kitchens and bathrooms.” Heflin said that she’s had clients ask if they should “bake cookies,” to create a pleasant, homey atmosphere and hide less pleasant odors. Laughing, Heflin said she tells clients to start with the “unsexy stuff first.”
Today, she said, “the number one issue is the heating system, followed by the roof. It used to be new granite countertops, but today, with the energy crisis, home heating and cooling is the top issue. Then new windows and siding.”
For Dietschler, the cookie idea doesn’t seem farfetched at all. “An appraiser will be in your home for at least a half hour, probably longer. A first impression is very important,” he said. “Getting rid of bad smells, cleaning up, all that’s important.”
The bottom line, Dietschler said, is that appraisers look at the same things as prospective buyers. “If the shrubs are overgrown, there’s mildew on the siding, the decks haven’t been sealed and are in need of a power wash, that’s important. If we do a drive-by and if it looks shabby outside, we assume it’s shabby inside. And so will a buyer.”
