After being on the Hardcore Mortgage Show on 97.1 The Ticket this morning, I knew I had to come home and blog about appraisal guarantees. We are already in a competitive Seller's Market again.  One of the things agents like to do is offer an appraisal guarantee.  But.. what is it?

Let's start by understanding the appraisal process.  When applying for a mortgage, most times, the lender requires an appraisal.  This is where a licensed appraiser, who has 2000 hours of education & training before they can even practice on their own, goes to the home and compares it to similar sales in the area.  Generally, the lender gives them instructions as to how to appraise the property.  Sometimes, they just need to walk through the house while other times, they have to measure every single room and make sure the square feet are exact. Unless there are particular circumstances, the appraiser will find homes that have sold in the last 3-6 months and within 1/4 of a mile of the home.  If he/she can't find enough, then they'll expand area and/or time frame. They make adjustments for the homes in comparison to yours and come up with a reasonable estimated value.

Now that that's out of the way, let's go into this guarantee.  First off, it is not truly a waiver.  I suppose those words can be interchangeable as long as the final understanding is that there will be an appraisal process and the buyer is agreeing to pay over that amount if necessary.  Secondly, as a buyer, you have to be comfortable (both mentally and financially) to pay with cash a certain amount higher than what the possible appraised value is expected to be.  I would suggest the buyer's agent should be running comps if he/she hasn't to get a reasonable value expectation.  There are times where even though the home of interest has multiple offers, the value may come in lower or higher than list price.  

Let's get down and dirty! Before writing an appraisal guarantee, make sure you have the finances to do so.  Also, make sure you're going to be in the home long enough to recoup the amount you may go over appraised value.  Essentially, you're buying with negative equity.  If the home is worth $150,000, but you're paying $155,000 then you're starting $5,000 in the hole.  This is no big deal if you plan to be in the home 3+ years.  Assuming standard market conditions, you'll get this back in equity over time.  

The best way to write an appraisal guarantee is to protect you but entice the seller.  So, if you write one, it's best to make it clear and simple.  Using our $150,000 house example, we know the seller wants $150,000.  If you're willing to pay an extra $5,000, protect yourself and the seller.  State the following: "Buyer to offer $5,000 appraisal guarantee.  Buyer offers up to $5,000 above appraised value as long as the home appraises at $145,000 with a maximum purchase price of $155,000." By writing it this way, you're telling the seller that they will get their $150,000 for sure.  If the home appraises at $150,000 you'll pay $155,000.  And for your protection, if the home appraises anywhere above $150,000 you'll also only pay $155,000.  This is a win-win scenario.  

If you write this appraisal guarantee the wrong way, you'll either leave yourself to pay X dollars over appraisal no matter what and/or tell your seller they may end up selling for less than list price.  For example, if you say "buyer to pay $5,000 over appraised value" then you have a totally different scenario than the one described above.  In this instance, if the home appraises for $142,500, you're only paying $147,500.  Sure, if you can get this offer signed it means the seller agreed to it, but they may have some major problems with this later.  Imagine the seller deciding they're better off taking you to court and not selling to you than agreeing to sell their home for $2,500 below market value.  Conversely, if the home appraises for $161,000, then you're the proud owner at $166,000.  Had you written it the other way, you would've been buying for $155,000 and the seller would be happy to receive $5,000 more than they thought when they put the sign in the yard.