Understanding Sales Price vs. Appraised Value and Their Impact on Your Mortgage Loan
When navigating the world of real estate, two critical concepts often come up: the sales price and the appraised value of a home. While they may seem interchangeable to first-time buyers, understanding the difference between these terms is crucial, especially when it comes to securing a mortgage loan. Let’s break down what they mean, how they differ, and how these values can influence the home-buying process.
Sales Price: The Agreed Amount Between Buyer and Seller
The sales price is the amount that a buyer agrees to pay and a seller agrees to accept for a home. This number is typically determined through negotiations between the buyer and seller, factoring in the market demand, the seller’s asking price, and the buyer’s offer.
For instance, if a seller lists their home at $300,000, a buyer may offer $290,000, and after some negotiation, they might settle on a sales price of $295,000. This agreed-upon price becomes the basis for the purchase contract, which legally binds both parties to the transaction.
However, it’s important to note that the sales price is not the ultimate determinant of the home’s value. Just because you’re willing to pay $295,000 doesn’t mean the property is objectively worth that amount. That’s where the appraised value comes in.
Appraised Value: The Objective Assessment of Worth
The appraised value of a home is determined by a licensed appraiser who evaluates the property’s worth based on a range of factors. These may include:
- Comparable sales of similar properties in the area (commonly referred to as “comps”).
- The size, condition, and features of the home.
- Market conditions, such as supply and demand in the local real estate market.
An appraiser’s job is to provide an unbiased, professional opinion of the home’s value. For example, after inspecting the property and analyzing market data, an appraiser may conclude that the home’s value is $290,000, even though the buyer and seller agreed on a sales price of $295,000.
How Sales Price and Appraised Value Impact Mortgage Loans
The relationship between the sales price and the appraised value is critical when securing a mortgage loan because lenders rely heavily on the appraised value to determine the amount they’re willing to lend.
Here’s why: mortgage lenders aim to minimize their risk. If the appraised value is lower than the sales price, it means the buyer is agreeing to pay more for the home than its fair market value. This discrepancy raises concerns for the lender, as the property may not fully cover the loan amount if the buyer defaults and the lender needs to sell it to recoup their losses.
Scenario 1: When Appraised Value Matches Sales Price
If the appraised value aligns with the sales price, the lending process moves forward smoothly. For example, if the sales price and appraised value are both $295,000 and the buyer is approved for a mortgage, the lender will typically finance a percentage of that amount (e.g., 80% loan-to-value ratio), while the buyer covers the remainder as a down payment.
Scenario 2: When Appraised Value Exceeds Sales Price
If the appraised value is higher than the sales price, the buyer essentially gets a great deal. For instance, if the appraised value is $305,000 but the sales price is $295,000, the buyer is purchasing the home at a price below its market value. This situation rarely causes issues, as the lender is more than willing to finance a property with a higher appraised value.
Scenario 3: When Appraised Value is Lower Than Sales Price
This is where complications arise. If the appraised value is lower than the sales price, the buyer and lender must address the gap. For example, if the appraised value is $290,000 but the sales price is $295,000, the lender will typically base the loan amount on the appraised value of $290,000, not the sales price.
This means the buyer must:
- Cover the difference out of pocket (in this case, $5,000).
- Renegotiate the sales price with the seller to match the appraised value.
- Walk away from the deal, which might be possible if a financing or appraisal contingency is included in the purchase agreement.
Why Understanding This Difference Matters
Being aware of the potential discrepancies between sales price and appraised value can save buyers from financial surprises during the mortgage process. Here are some practical tips to navigate this:
- Do Your Research: Before making an offer, research comparable home sales in the area to ensure your offer aligns with market values.
- Include Appraisal Contingencies: An appraisal contingency in your contract gives you the option to renegotiate or exit the deal if the appraised value comes in lower than expected.
- Be Prepared for Additional Costs: In hot housing markets, bidding wars can push sales prices above appraised values. Be prepared to cover any gaps if needed.
Conclusion
Understanding the interplay between sales price and appraised value is essential for anyone entering the housing market. While the sales price reflects the amount you agree to pay, the appraised value determines the home’s objective worth and heavily influences your mortgage loan. By keeping these factors in mind, buyers can make more informed decisions, avoid unexpected costs, and set themselves up for a smoother home-buying journey.
Navigating the complexities of real estate can feel daunting, but with the right knowledge, you’ll be better equipped to handle these challenges and achieve your dream of homeownership. Let’s make smart moves together!