How Does a Lender Evaluate Properties?

A lender evaluates a property mainly through an appraisal: a state-licensed or state-certified appraiser, arranged by the lender rather than by you, estimates the home's market value from recent sales of similar homes and reports any problems with its condition. For a purchase, lenders generally base your loan on the lower of the appraised value or the price; that sets your loan-to-value ratio (LTV), the loan amount divided by the home's value, which drives your down payment and whether you need mortgage insurance. If the home has problems that affect safety or soundness, the appraisal is made subject to repairs, and the lender needs proof they were fixed. Some conventional loans skip the appraisal when Fannie Mae's software accepts the value.

Who orders the appraisal, and who pays for it?

The lender orders the appraisal, under rules that depend on the loan:

• Conventional loans sold to Fannie Mae: under Fannie Mae's Selling Guide, its rulebook for lenders, the lender or a company it hires selects a state-licensed or state-certified appraiser. The lender may not use an appraisal ordered by the borrower, the seller, or a real estate agent.
• FHA loans, insured by the Federal Housing Administration: the lender must choose an appraiser from FHA's Appraiser Roster, and it may not let a mortgage broker or commission-paid loan staff select, manage, or pay the appraiser.

Federal rules let the lender charge you a reasonable fee for the appraisal itself, but your copy of the report must be free.

Federal appraisal independence rules apply to loans secured by your principal home. They bar the lender, mortgage broker, real estate agent, and other companies involved in the closing from pressuring the appraiser to hit a target value, threatening to withhold payment over the value, or tying the appraiser's pay to whether the loan closes. The appraiser cannot have a financial interest in the property or the deal. The lender can still ask the appraiser to consider more comparable sales, explain a conclusion, or correct errors.

How does the appraiser decide what the home is worth?

The appraiser compares your home with recent sales nearby. Fannie Mae requires at least three closed comparable sales, often called comps, which should generally have closed within the last 12 months and be similar to your home in site, room count, finished area, style, and condition. The appraiser adjusts each comp's price for its differences from your home. Older or more distant sales are allowed when the appraiser explains why, for example in a rural area with few recent sales.

For a purchase, Fannie Mae's rules use the lower of the sale price or the appraised value to set your LTV. Here is how a low appraisal changes the numbers:

• Price: $400,000. Planned down payment: 10%, or $40,000, for a $360,000 loan.
• Appraised value: $380,000.
• New LTV: $360,000 divided by $380,000 is about 94.7%, not the 90% you planned.
• To keep a 90% LTV, the loan can be no more than $342,000 (90% of $380,000). The cash you need rises to $58,000, or $18,000 more than your planned down payment.

A conventional loan with an LTV above 80% generally requires mortgage insurance, so a lower value can also raise your monthly cost.

What condition does the home have to be in?

Each loan program sets its own standards, and the appraiser reports against them:

• Conventional loans (Fannie Mae): the appraiser must report any deficiency that could affect the home's safety, soundness, or structural integrity. The appraisal is then made "subject to" completing the repairs, or to an inspection by a qualified professional, and the lender must have proof the problem was fixed. Minor wear, such as worn carpet, holes in window screens, missing handrails, or cracked window glass, can be accepted "as is" if the appraiser reports it and the value reflects it. Signs of wood-boring insects, dampness, or abnormal settlement (sinking of the foundation) require proof the problem was corrected or a professional's report that it poses no threat of structural damage.
• FHA loans: FHA's Minimum Property Requirements say every home it insures must be safe, sound, and secure. The appraiser lists the repairs needed to meet them, with an estimated cost for each. The lender may approve the property only after it confirms that the defects the appraiser reported have been corrected.

An appraisal is not a home inspection. Fannie Mae's guide says appraisers are not responsible for hidden or unapparent conditions, so hire your own inspector if you want the home's systems and structure checked in detail.

When can a lender skip the appraisal?

On some conventional loans, Desktop Underwriter, the software Fannie Mae provides lenders to evaluate applications, offers "value acceptance": Fannie Mae accepts the lender's value estimate and no appraisal is done. Offers are possible for one-unit homes, including condos, on certain purchases and refinances of primary residences and second homes, and on refinances of investment properties. Exclusions include:

• two- to four-unit properties, co-ops (shares in a cooperative building), and manufactured homes;
• homes not yet built, construction-to-permanent loans (one loan that pays for building the home and then becomes the mortgage), and Fannie Mae renovation loans;
• homes priced or valued at $1,000,000 or more;
• purchases that use a gift of equity, a credit from a seller, often a relative, that hands you part of the seller's equity.

The lender decides whether to use an offer. It must order an appraisal anyway if the law requires one, if it is counting rental income from the property to qualify you, or if it believes an appraisal is warranted.

When do you get a copy of the appraisal?

For a first mortgage on a home, meaning the main loan with first claim on the property, federal rules under the Equal Credit Opportunity Act require the lender to:

• tell you in writing, within three business days after you apply, that you have a right to copies of appraisals;
• give you a copy of each appraisal and other written valuation promptly once it is completed, or three business days before closing, whichever is earlier;
• provide those copies free;
• follow these rules even if your application is denied, withdrawn, or incomplete.

The lender may ask you to waive that timing and take the copy at closing instead, and any waiver must be given at least three business days before closing. Declining keeps the earlier deadline, which leaves you time to check the report and challenge it before you sign.

What can you do if the appraisal comes in low?

Read the report first. Check your home's details, such as square footage and bedroom count, and whether the comps are recent and similar in size, style, and condition. Then use one or more of these options:

1. Ask for a reconsideration of value (ROV), a formal request for the appraiser to take another look. On loans sold to Fannie Mae, the lender must explain its ROV process when it gives you the appraisal, and you can file one ROV per appraisal before closing. Your request must say what you believe is wrong and can include up to five other comparable sales, with their sources, and why they support a different value. On FHA loans, the lender's underwriter (the staff member who approves the loan) decides whether to ask the appraiser to reconsider, so send your evidence to the lender.
2. Renegotiate the price with the seller, using the appraisal.
3. Pay the gap in cash, as in the example above.
4. Cancel, if your contract allows it. On an FHA or VA loan, if you signed the contract before learning the appraised value, it must include, or be amended to include, a clause that lets you cancel without losing your earnest money (your good-faith deposit) if the value comes in below the price, or go ahead anyway. For VA loans, the value that counts is the "reasonable value" VA sets. FHA's clause is not required for some sales, such as homes sold by HUD, Fannie Mae, Freddie Mac, VA, or a lender selling a foreclosed home. On a conventional loan, your right to cancel depends on your contract, so check whether it has an appraisal contingency, a clause that lets you back out or renegotiate if the value is low, before you sign.

Each lender writes its own ROV procedures within these program rules, so ask how disputes work when you choose a lender. The mortgage approval process covers the other underwriting steps that run alongside the appraisal.