In order to assess the current market worth of a property, banks conduct appraisals. They do this to avoid “overinvesting” in the loan by putting up more money than the house is worth. They also want to know the property’s prospective selling worth in case they need to foreclose, seize, and resell it later.
Another way to look at it is as follows. Banks assess homes in order to safeguard their investment. If you take out a loan for 20% of the purchase price, the lender will cover the remaining 80% of the cost. They are, in a sense, the majority shareholder. As a result, they want to make sure that, in the case of a default and foreclosure, they don’t find up with a property that is worth less (in today’s market) than what they paid for it.
Appraisals are a good business practice and are now required for almost all mortgage loans.
In Theory, Banks Do Not Appraise Homes; Instead, They Hire An Appraiser
Let’s get explicit about this. Before giving money to a buyer, banks do not assess the property. Once the buyer and seller have signed a purchase agreement, they employ a professional house appraiser to do the appraisal. After that, the appraiser will give a copy of the value report to the lender, who will use it to make a financing and underwriting decision on the property and loan.
The sale will most likely move through if the property is appraised at or above the mutually agreed-upon purchase price. You’ve encountered a snag if the lender’s appraiser determines that the property is worth less than what you agreed to pay for it. In the latter situation, the loan may be delayed until the homeowner (A) decreases the sale price or (B) the buyer makes up the difference. ‘Scenario A’ occurs more frequently than ‘Scenario B.’
As a house buyer, you should add a contingency in your purchase agreement that permits you to back out if the home appraises for less than the purchase price. In this case, the contingency clause should protect you from losing your earnest money deposit. But that’s a very different topic (follow the link to learn about it).
A Home Inspection Is Not The Same As A Property Inspection
The appraisal is frequently confused with the house inspection by first-time home purchasers, and vice versa. Many people mistakenly believe they are the same thing, but they are not. The appraiser and the inspector have two distinct tasks to do for two distinct “bosses.”
- By evaluating the market value of the property before the loan is finalized, the appraiser is looking out for the lender’s interests. The main objective is to figure out how much anything is worth.
- By analyzing the condition of the home prior to closing or settlement, the inspector is looking out for the buyer’s best interests. The inspector is searching for flaws, deterioration, and possibly dangerous situations. The main purpose here is to figure just how bad things are.
So, why do banks conduct house appraisals before making a loan to a borrower? They do so to verify that neither the buyer nor the bank is overpaying for the property. In the case of foreclosure and repossession, they do so to lower their odds of ending up with an overvalued item. In other words, they do it in order to make a good investment.