Home sales are competitive right now. In many markets, offering the asking price isn’t enough…
As a mortgage professional I can not tell you the number of people that do not understand the difference between an inspection and an appraisal. If you fall into this category here is a guide for you:
What is an Inspection?
An inspection is typically and interior and exterior inspection of the property that you are in contract to purchase. Typically an inspection is done in the first 10-14 days after a contract becomes fully executed (all parties have signed). A buyer will find and hire a licensed inspector and often pest inspector to inspect the property and comment on age, sustainability, and life expectancy of all systems as well as spot any deficiencies. These inspections tend to be hours long and include the inspector going inside, outside, up on the roof, in the attic, in the crawl spaces, etc. The buyer is usually present for the inspection and the inspector will point out any notable items at the time of the inspection. Upon completion of the inspection the inspector (and/ or WDO inspector) will complete a comprehensive inspection report. The inspection report will list the age, make, and life expectancy of all major systems including heating, cooling, plumbing, electrical, roof, etc. If there are any deficiencies noted the buyer may use the report and findings to have their agent negotiate for repairs, concessions, or other remedies. Sometimes the findings will result in the buyer walking away from the deal. All of the above is permissible during the inspection period that is defined by the purchase and sales agreement.
The results of the inspection are also used by insurance companies when binding insurance. A four-point inspection report will list the age and make of all major systems so that insurance companies can insure you accordingly. This is important because there are some exclusions based on type and / or age of systems so it is important that your insurance policy covers the types of systems (wiring, plumbing, roof) that your property has. Wind Mitigation inspections are important for homes built before newer building codes. A wind mitigation report can save the home buyer tons of money on their home insurance, it is used to certify the roof’s age and that is was installed to current building codes.
Property Inspections are NOT required for most mortgages. For a VA loan a clear Wood Destroying Organism (termite and fungi) report is required for the property. Occasionally certain circumstances may warrant the lender to ask for the inspection report but it is not often. If the purchase contract or any addendum references repairs or concessions due to deficiencies in the home the lender may ask for the report and sometimes even invoices to prove that the issues have been remedied.
* For FHA loans the borrower / buyer must be given a disclosure “For your protection get a home inspection,” this does not mean they need to get an inspection but lenders are required to make sure they have been advised that it could potentially be a wise decision.
What is an Appraisal?
An appraisal is a report prepared by a licensed appraiser. The licensed appraiser uses recent closing, listings, and pending comparables to determine the value of the property. An appraisal is usually REQUIRED by the lender. The lender wants to make sure the property that they are securing a loan with is worth what they are lending.
A conventional appraisal is the most basic of appraisals. The appraiser will complete an interior and exterior inspection of the property. They will take photos and make commentary on the neighborhood, market, terms of the contract and home. They will use comparables that may be listed, sold, or pending in order to determine the value of the property. The appraiser will site the other comparables in the report and make adjustments to the comparables to put them in line with the property. Example: might add or subtract value if there is more/less square footage, bathrooms, etc. The appraisal report is sent to the lender and borrower for review upon completion.
An FHA Appraisal is a little more elaborate than a conventional appraisal.The appraiser needs to be a HUD-approved home appraiser. They will assign a value to the property as well as determine that it meets HUD’s minimum property standards.
Appraiser looks for peeling paint, loose handrails, cracked tiles, etc.
Appraiser takes photos of the sides, front, rear of the home, and any property adding improvements (ex: pool)
Photos of appliances working
Photos of mechanical systems
Photos of attic space
No exposed Wiring
The property needs to habitable, comfortable, and without hazards
A VA Appraisal is unique to VA loans, the report must be done by a VA certified appraiser and ordered through the VA. A VA loan serves two purposes. First that the property’s value is sufficient for the loan being taken and also that the property meets VA’s Minimum Property Requirements (MPR). The MPR major guidelines are the following:
Residential property only (for primary residence)
Must have adequate living space
Mechanical Systems working and safe (electrical, plumbing, heating, cooling)
Safe Water Supply
Roofing in good condition
No health and/ or safety hazards
Lead Based Paint fee
There can generally be no visible wiring, peeling paint, cracked tiles, visible deficiencies
In addition to the appraisal report you will likely need a clear Wood Destroying Organism (WDO) report. If evidence of WDO is notated it will need to be remedied and a clear WDO report will need to be delivered prior to the loan closing.
What if Deficiencies are noted on my Appraisal or it does not appraise “As-Is”?
In some appraisal reports the appraiser will include photos or commentary of items in ill repair or notate that the report is “subject to.” A report with the verbiage “subject to” means that it does not meet the minimum standards and that items need to be repaired. Example: “subject to repair of cracked tile in shower,” in this scenario the homeowner will need to repair the cracked tile in the shower and the appraiser will need to come back out take photos and amend the report to be “As-Is.” An “as-is” notation means that the property is at the value listed in the report with no additional changes needed. Occasionally the appraiser will deliver a report “as-is” but add photos or commentary about deficiencies on the property. It is not uncommon for the underwriter to request that these items be repaired. The additional trip will often cost the buyer a re-inspection fee ($100-175) so it is important these items are identified and repaired prior to the initial appraisal inspection.
What if the property does NOT appraise for the contract price?
There are two sides to this situation.
1. The property appraises for MORE than the contract price. This is great for the borrower/ buyer, they have instant added equity in the property. Not so great is that as far as the lender is concerned it’s icing on the cake, it does not have any implications when it comes to the rate or mortgage insurance. It will not change your minimum contribution or loan to value, lenders will still base the loan scenario off the contract price.
2. The property appraises for LESS than the contract price. In this scenario the borrower/ buyer has two options, they can go back to the seller and ask for a reduction in the price or figure a way to restructure the loan. It is not uncommon for the seller to give the reduction due to the fact they may have this issue down the road with any other prospective buyers. If the property appraises low once it may do it again. However in some scenarios sellers will not budge on the price. If the new price does not provide sufficient proceeds for them to sell or they just don’t want to lower the price they do not have to, it is up to the seller. If the seller does not come down on price, or comes down but not to the appraised value the borrower / buyer has the option to come up with the extra funds (to make up the difference) or restructure the loan and have lower loan to value. Your mortgage professional can help you to restructure the loan and speak with your real estate agent to navigate this process.
Property Inspection Waivers:
Occasionally a loan scenario will be awarded a property inspection waiver. This means that the property does not need to be appraised for the purpose of the loan. The great news here is that the buyer / borrower saves around $500 on the cost of the appraisal. However there is no rule of thumb to indicate what properties and loan scenarios will get a property inspection waiver. The Automated Underwriting Systems (Desktop Underwriter and Loan Prospector) dictate what loan scenarios and properties are awarded the coveted property inspection waiver. In my experience the scenarios tend to include 20% down, with excellent credit (at a minimum).
Appraisals for Refinances:
There are many types of refinance transactions. For some, but not all, appraisals are needed. For VA and FHA loans if you chose to do a “Streamline” Option in which you do a rate and/or term reduction appraisals are not needed. In the event that you change loan types (from FHA to Conventional) or do a Cash-Out option appraisals are needed. An appraisal for a refinance is different from an appraisal on a purchase because there is no purchase contract. The owner/ borrower may dictate what they think the property is worth and the appraiser is tasked to do an appraisal inspection, use comparables, and assign a price to the property. Borrowers (owners) are often not correct on their estimated value of the house. I would say that at best fifty percent of the time the owner / borrower provides the correct valuation of the home. If the appraiser assigns a value that is less than the owner/ borrower expected there can be implications with the loan structure. For example; if the owner was hoping to cash out at an 80% loan to value and the property value is less than they expected the cash out amount / loan amount will need to be lowered as well.
To sum it up the most significant difference between and Inspection and an Appraisal is that the inspection is NOT required by your mortgage lender. However the Appraisal is not nearly as thorough as an inspection so it is often wise to do an Inspection when entering into a purchase contract on a property. With the results of the inspection you can save on your insurance, make sure you are properly insured, and address any concerns or items that you may have that arise from the inspection. If you opt not to have the items repaired while in escrow you can always try to negotiate a seller’s concession or price reduction to help offset the cost of the repairs. As a reminder appraisals are often REQUIRED by the lender so there is usually no getting around this. This is a required item and the cost will be disclosed on any loan estimates you may receive. I advise getting pre-approved and talking to a mortgage professional before going into contract on a home. A mortgage professional can help you identify what type of loan you may need and advise what condition the property needs to be in to pass the appraisal. This could save you time, frustration, and money.
If you have any additional questions about the mortgage process or want to talk to a mortgage professional about your loan scenario and what you can qualify for please reach out to us – Carbon Capital at 904-513-800.