Home Appraisals: What Happens When an Appraisal Comes in Low

Your lender's appraisal can decide how much you are able to borrow, and a value below your purchase price can leave you needing more cash at short notice. Here is how home appraisals work, how lenders and mortgage insurers use them, and what your options are when the number comes in low.

The short version

Who orders the appraisal, and who pays

When you buy with a mortgage, the lender or mortgage insurer decides whether an appraisal is needed and what kind fits the file. The Appraisal Institute of Canada (AIC) explains that the appraiser's client is the lender, which gives the instructions, even though the homeowner is often required to pay the fee. CMHC also notes that your bank or credit union may require an appraisal at your expense.

• The fee. The AIC says an appraiser's fee is generally a flat fee set by the complexity of the job and the hours it takes, not by the home's value.
• The report. The appraiser needs the lender's written authorization to release the report to anyone else, including the person who paid for it. Ask your lender up front who pays and whether you will get a copy, approved or not.

Who does the appraisal

The AIC grants two designations. An AACI (Accredited Appraiser Canadian Institute) can value any type of property. A CRA (Canadian Residential Appraiser) values homes with up to four self-contained units and individual undeveloped residential sites. Designated members follow the Canadian Uniform Standards of Professional Appraisal Practice (CUSPAP).

OSFI, the federal regulator of banks, expects lenders that use outside appraisers to make sure they are designated, licensed or certified, and independent of the people arranging and approving the loan. As the AIC puts it, the appraiser provides an assessment of value and doesn't advocate for a target number.

What the appraiser looks at

A full appraisal starts with a visit, which the AIC says usually takes 20 to 40 minutes. The appraiser looks at:

• The buildings. The physical characteristics of the home and any outbuildings.
• Finishes and systems. Interior and exterior finishes, and systems such as heating and cooling.
• Quality and condition. The quality of the construction, and any deficiencies or repairs needed.

The appraiser also studies the market, often analysing 3 to 10 or more comparable properties, and may ask about the home's own listings and offers in the past 12 months and its sales in the past three years. The AIC describes three approaches: direct comparison with sales, listings and pending sales of similar properties; the cost approach, which is more reliable for newer buildings; and the income approach, which is typically not applied to a home.

Full appraisals, desktop reports and automated valuations

Not every purchase gets a full appraisal. The AIC describes three kinds of report:

• Full appraisal. An interior and exterior inspection with comprehensive research and analysis.
• Drive-by report. Exterior only.
• Desktop report. No site visit; the analysis is based on available data.

For mortgage financing, the AIC says drive-by and desktop reports fit only a first mortgage on a home that isn't under construction or renovation. Recent information must be available, such as an MLS® listing or inspection from the past three years, and the lender must accept a limited-scope report. Lenders may also use automated valuation tools. OSFI expects federally regulated lenders to combine methods, from on-site inspections and third-party appraisals to automated tools, to monitor how well those tools reflect market value, and generally not to rely on any single method.

How lenders and insurers use the value

The AIC sums it up: if you pay well above the appraised value, the lender uses that value, not the price, to set the maximum loan, and you may not get the full loan you were counting on.

• Insured mortgages, with less than 20% down. Under the federal Eligible Mortgage Loan Regulations, the loan is based on the value the lender or mortgage insurer ascribes to the home, verified by a method that prudent lenders, insurers or appraisers accept. On a purchase, that value can't exceed the price. The loan can be at most 95% of the first $500,000 of value and 90% of the rest, and the value must be under $1.5 million. Lenders are expected to meet the insurer's valuation requirements so the insurance is valid.
• Conventional mortgages, with 20% or more down. By law, a purchase mortgage from a bank or other federally regulated lender must be insured if it is more than 80% of the value. A low appraisal can push a loan that was 80% of the price above 80% of the value.

When the appraisal comes in low

Here is how a shortfall works, with example figures:

• An insured purchase. You agree to pay $700,000 and plan the minimum down payment of $45,000 (5% of the first $500,000 and 10% of the rest), with a $655,000 mortgage. The home appraises at $680,000. The loan is now based on $680,000, so the most you can borrow, not counting the insurance premium, is $637,000, and you need $63,000 of your own money: $18,000 more than planned.
• A conventional purchase. You agree to pay $900,000 with $180,000 down and a $720,000 mortgage. The home appraises at $860,000. At 80% of that value, the lender can lend $688,000 without insurance, so you need $212,000 down: $32,000 more. Keeping the larger loan would generally mean mortgage default insurance and its premium.

Your options:

• Add to your down payment. The simplest fix, if you have the savings or a gift from a relative.
• Renegotiate. While your subjects are in place, you can ask the seller to lower the price or meet you partway. The seller doesn't have to agree.
• Try another lender. Lenders' standards vary. The AIC notes that a new lender may need permission, revisions or other documents before relying on the original report, so ask what it needs.
• Ask your lender to take another look. The appraiser works for the lender, so questions go through the lender, not to the appraiser. If you think the report missed something, such as recent upgrades or relevant recent sales nearby, give the details to your lender or mortgage professional; whether it orders a review or a new report is its decision.
• Let the deal end, if your subjects allow. If you can't close the gap and your financing subject can't be satisfied despite genuine efforts, the contract can end, and your deposit is generally returned once you and the seller sign a release. Once subjects are removed, a low appraisal doesn't change your obligation to complete.

Protecting yourself in the offer

• A financing subject with specifics. BCFSA's sample clause makes the deal subject to you receiving "a satisfactory mortgage financing commitment," and suggests setting out the specific terms you need. Don't remove it until your lender has approved this home.
• An appraisal subject. You can also make the purchase subject to the home appraising at or above an amount you set, such as the price. BCFSA has no sample wording for this, so it should say whose appraisal counts.
• An appraisal before you sign. The AIC recommends working with your lender to have a designated appraiser complete an independent appraisal before you sign the purchase agreement.
• Care with subject-free offers. BCFSA warns that offering more to win a home may mean it is appraised for less than you paid. Without a financing subject, any shortfall is yours to cover.

Appraisal, assessment or market analysis?

• Appraisal. An independent opinion of value, prepared by a designated appraiser for your lender.
• BC Assessment. Market value as of July 1 of the previous year and the home's physical condition as of October 31, used to share out property taxes. By the time you buy, it can be well behind the market. See BC Assessment vs Market Value.
• Comparative market analysis. A REALTOR®'s comparison with recent sales and current listings of similar homes, used to set a list price or plan an offer. See Inside a Comparative Market Analysis.

Questions buyers often ask me

Who pays for a mortgage appraisal?

Often the buyer, although the lender is the appraiser's client and gives the instructions. Policies vary, so ask your lender before it orders one.

Can I get a copy of the appraisal?

Ask your lender. The appraiser needs the lender's written authorization to release the report to anyone else, including the person who paid for it.

What happens if the appraisal is lower than my purchase price?

Your lender bases the loan on the lower value, so you generally need to cover the gap. You can add to your down payment, renegotiate while your subjects are in place, try another lender or ask your lender to take another look.

Does every purchase need a full appraisal?

No. The lender or mortgage insurer decides whether an appraisal is needed and what kind. Some files use an exterior-only or desktop report, and lenders may also use automated valuation tools.

Is an appraisal the same as my BC Assessment?

No. Your assessment reflects market value as of July 1 of the previous year and is used for property taxes. An appraisal is an opinion of value prepared for your lender at the time you borrow.

Planning your purchase? Read How Much House Can You Afford? and Closing Costs in BC, or try my mortgage calculator.

This article is general information, not financial or legal advice. Details come from the Appraisal Institute of Canada, OSFI, CMHC, the Financial Consumer Agency of Canada, federal mortgage insurance rules and BCFSA, and were current at the time of writing; the examples use illustrative figures. For the Appraisal Institute of Canada's guide, see appraisals for residential property owners.