Bank appraisals have always been a part of the buying process. With low inventory and high buyer demand driving Ottawa home prices up, it is important to understand how an appraisal could impact the purchase of a property.
How do bank appraisals work?
The appraisal is done to ensure that the lender is protected. If the bank is lending you money for a mortgage, they want to ensure that they are protected if you default on that mortgage. The appraiser will assess the current condition of the home and review recent sales and comparable homes.
Who pays for it and when does it happen?
The bank will order the appraisal and may or may not pay for it. It typically happens after your offer to purchase has been accepted but before the closing date. Ideally, you’ve had the ability to put in a financing clause into your agreement and the appraisal should be done before that condition expires. If you don’t include a financing clause, you are taking on the risk if the appraisal falls short of the required mortgage value.
What happens if the bank appraisal comes in less than you offered?
Scenario #1: Let’s say you have an agreement in place to pay $800,000 and you’re a homebuyer with a 20% downpayment ($160,000). You need a mortgage of $640,000. The appraisal is ordered but the value of the home is assessed at $750,000. This means:
- The bank is only willing to give you a mortgage for the house based on 80% of the assessed value ($600,000)
- The $40,000 difference will have to come from somewhere. The bank will take it out of your downpayment. This leaves you with a $120,000 downpayment which is only 15% of the purchase price. Now, you will have to pay CMHC insurance.
Scenario #2: Let’s say you have an agreement in place to pay $800,000 and you’re a homebuyer with a 5% downpayment ($40,000). You need a mortgage of $760,000. The appraisal is ordered but the value of the home is assessed at $750,000. This means:
- The bank is only wiling to give you a mortgage 0f $712,500 (95% of the assessed value)
- The difference of $47,500 is more than your downpayment and will have to come from somewhere. If you can’t borrow it, you may be out of luck, especially if you are purchasing at the top of your range (avoid, avoid, avoid).
If the appraiser doesn’t agree with the amount you’ve agreed to with the seller, you have options:
- find another lender.
- your agent can present comparable sales. If you have a longer closing in a rising market, the sales that happen closer to the closing date will be helpful.
- come up with the difference (hello Mom and Dad!).
How do you protect yourself?
- In an ideal world, you’d be able to include a financing condition and have the bank appraisal done during the conditional period.
- You should have a contingency fund, just in case you need to make up the difference.
- Avoid purchasing a home at the top of your budget.
- Don’t go crazy with the purchase price. Homes will increase with every sale in a rising market. But offering way beyond what the market will support just to win the bid may not be the most wise decision.
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