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An appraisal is an expert's opinion of the value of a home. The key word is opinion: an appraisal is an estimate, not an absolute value. The real value of a home is what a buyer is ready, willing, and able to pay.
At the same time an appraisal is probably the best way to accurately estimate the value of a home. Banks and lenders use appraisals to determine how much money to lend, and investors use appraisals to help determine how much to pay.
Quick note: An appraisal is a formal, third-party, objective estimate of a home value. A competitive market analysis, typically performed by a real estate agent, is another method used to estimate value. Competitive market analyses are commonly used to help you determine what to list your home for based on "competition" with other homes for sale in your area. While a competitive market analysis is also a good estimate of value, an appraisal is the only method lenders and other financial professionals rely on.
Types of Appraisals
Appraisers use different methods; here are the two most commonly used techniques used to estimate the value of a home:
Appraisers typically compare your property to at least three comparables but sometimes more. If closely-matching comparables cannot be found, the appraiser will note the differences and apply a value to those differences. For example, if your home has a detached garage and all available comparables do not, the appraiser will add an amount to the value of your home. Basically, appraisers adjust the estimated value up or down to compensate for the presence or lack of additional features.
While appraisals are based on objective analysis, an appraiser does have latitude when determining the value of your home. Three appraisers will almost always come back with different values for the same home (hopefully fairly close, though). Again, an appraisal is an estimate.
Cost appraisals are usually considered to be more accurate when a home is fairly new since it is easier to estimate a replacement cost. Cost appraisals are also relied on when a home is unusual or in large part unique and it is hard to find appropriate comparables.
Some appraisers use both techniques as a way of sense-checking results, but they may or may not include the results of both techniques on the formal appraisal report.
What does a formal appraisal look like? Your report should include:
Keep in mind while an appraisal may include notes about the condition of the home, it in no way is a thorough inspection of a home; don't rely on an appraisal to determine if a home is in good shape and whether all systems function properly. Home inspectors evaluate condition; home appraisers evaluate market value.
Why Appraisals are Important
If you are borrowing money using the home as collateral − like for a mortgage or home equity loan or line of credit − the appraisal value must be at least equal to or preferably greater than the loan value. Think of it this way: No lender should be willing to let you borrow more than the home is worth.
Many lenders follow pre-established guidelines and may only be willing to lend a percentage of the home's appraised value. If the appraisal comes in too low, you may for example be asked to make a larger down payment to make up the difference. Or, you may be able to renegotiate the sales price with the seller based on the appraisal coming in low; if he or she is unwilling to drop the price, you can cancel the deal with no penalty as long as your contract to purchase the home was contingent upon obtaining suitable financing.