Appraisals can impact the Loan to Value (LTV). The LTV is determined by taking the loan amount and dividing it by the property’s determined value.
Example: a $400,000 valued home with a $380,000 mortgage has a 95% LTV. Different mortgage loan programs have different LTV requirements.
Getting House Ready for Appraisal When Purchasing
For purchase mortgages, the appraisal either validates or determines the mortgage loan to value (LTV). LTV is calculated by dividing the loan amount by the lesser of the sales price or the appraised value.
Let’s throw out a few different scenarios to highlight how the appraisal impacts financing when getting the house ready for an appraisal. If the home is being purchased for $400,000 and the loan amount is 380,000 then the initial LTV is 95% ($380,000 / $400,000). The final LTV is set when the appraisal arrives and determines the value.
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- Home appraisal process (great overview of the process)
- Don’t pay for the appraisal too soon
- How appraised value is determined (hint: it’s not price per square foot)
- Avoid appraisal pitfalls
- Appraised value vs. sales price – how to prepare for the worst
- How to fight a low appraisal
Let’s assume the appraised value comes in exactly at $400,000 and matches the purchase price (which is extremely common). In this instance, the final LTV remains at 95% and everything moves forward as planned.
Appraised value is higher than the sales price = great
Now let’s assume the appraised value comes in high at $405,000. The loan continues forward with a final LTV of 95%. Remember, the LTV for purchase home loans is the lesser of the sales price or the appraised value. The extra $5,000 in this example can be used as a method to pay for closing costs via seller concessions. Unfortunately, there isn’t any other advantage beyond the seller concessions for a high appraisal other than a “good for you” and built in equity.
Appraised value is lower than the sales price = bad
The worst case scenario is when the appraisal comes in below the sales price of $400,000. Let’s use a $395,000 value for this example. The final LTV is now 98.75% (380,000 / 395,000) and not the initial 95%. This changes the terms of the loan and puts the loan on hold. There are a few potential outcomes.
Seller reduces the price
The borrower can renegotiate with the seller and have them reduce the price to $395,000. Assuming the seller agrees to reduce the price, the new loan amount would need to be $375,250 to achieve the initial LTV of 95% (395,000 x .95). As a result, the 5% down payment went from $20,000 down to $19,750 (395,000 x .05). This is great as it reduces the amount due at closing. Once the price reduction is official, the lender will send updated lender disclosures and the loan resumes moving forward.
Options if Seller does not reduce the price
If the sellers won’t reduce the sales price then the borrower would need to increase the down payment to get to keep the LTV at 95%. Since the LTV is now based on the appraised value of $395,000 the down payment of 5% will need to be $19,750. In addition to this amount, the borrower will need to bring an additional $5,000 (the difference between the sales price of $400,000 and the appraised value of $395,000). The total amount for the down payment would be $24,750 ($19,750 + $5,000). Obviously, this increases the costs to close.
Another option if the seller won’t budge would be to explore a different program that allows for the higher LTV – which is 98.75% in this example. The closing cost, loan terms, and even the interest rate are subject to change – even if the borrower locked in an interest rate.
The borrower can request a reconsideration of value from the Appraiser if they believe the report is inaccurate. Please see contest the appraised value for details.
The last resort option would be to terminate the contract if the buyer and seller can’t come to agreeable terms. Whether the earnest money is refunded depends on a variety of factors, such as the option period, financing period (per the contract).
Getting House Ready for Refinance Appraisal
For refinance home loans the LTV is determined by dividing the loan amount by the appraised value. The higher the appraised value, the lower the LTV. The appraisal for a refinance is a major influence as it can help avoid mortgage insurance (MI) and help answer the question “should I refinance my mortgage?”. Check out our blog on getting house ready for refinance appraisal.
The tough part about refinances is that preliminary numbers are run with estimated home values. Until the borrower makes the $500-$700 investment on an appraisal the numbers are only estimates and subject to change. If the value doesn’t come in high enough the numbers may change such that the refinance may not make financial sense. At that point, the out-of-pocket money was a gamble that didn’t pay.
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