Gather Little by Little

I mentioned in my Friday gathering last week that we received the appraisal on our new home. We knew we were getting a great deal already, but to see on paper that we were walking into a home with almost $40,000 in equity was a great feeling.

Our bank ordered our appraisal and used a company they contract with. I received a copy of the appraisal directly from my mortgage processor. Opening it up and reading through it was a little overwhelming at first. I had to do a little digging to figure out what everything met and how the numbers were derived. This was especially true concerning the comparable properties and how they compared the prices. That completely confused me at first.

I wanted to share with you what I learned and teach you how to read an appraisal.

What is an appraisal?

Before we jump in with out to read one, let’s do a quick review of what an appraisal is. An appraisal is an opinion or estimate on the value of real property. This value is generally expressed as Market Value. An appraisal is performed by a licensed or certified appraiser and done so using a standard format called the Uniform Residential Appraisal Report (URAR). The most current format of the URAR is the “Fannie Mae Form 1004”.

Appraisal requirements include:

• Interior and exterior inspection of the subject property.

• A street map that shows the location of the subject property and of all comparable properties that the appraiser used.

• An exterior building sketch of the improvements that indicates the dimensions.

• Clear, descriptive photographs of the subject property and comparable sales used.

The appraisal report (URAR) is broken up into sections. The sections are noted in the Fannie Mae form using text that flows vertically and is white on black. Some of the more common sections (by are not limited to):

• Subject: Basic information such as the address, legal description, owner’s and/or borrower’s names. The client is also identified here.

• Contract: Information on the contract for sale is entered here for appraisals in which a change of ownership is about to occur.

• Site: Data on the size, shape, zoning and access to utilities as well as FEMA flood-zone information

• Improvements: Physical characteristics of the property such as age, materials, and condition

• Sales comparison approach: The grid analysis, this is where the property being appraised is compared to recent sales of other properties.

How to read an appraisal

Now that we understand what the appraisal is and how it’s laid out, let’s walk through how to read one.

1. Scan page 1 and make sure the information is accurate. This page generally contains the Subject, Contract, Site, and Improvements sections. Since our home is in a small neighborhood, there was also a section called Neighborhood. If any of this information is inaccurate, call the appraiser or mortgage company right away. This information is used to as input into the comparable properties section, which is where the market value of home is determined.
2. Turn to page 2. Here is the “meat and potatoes” of the appraisal report and includes Subject property (the home being appraised) in one column, followed by generally 3 other comparable properties. If additional comparable properties where used, these can be found later in the report. The top 3 comparable properties will be listed here though. The appraiser is required to list homes that have sold within the last 6-months and are within very close proximity to the home being appraised.
3. Review the comparable properties. Each comparable property will have two columns. The first is a description which will line up with the subject property and the other comparable properties. Next to this will be an adjustment. The adjustment is the most confusing part for me, but also the most important. Since each property is unique, making comparisons is difficult. The concept is to simulate the price that would have been paid if the comparable properties were actually identical to the subject. If the comparable properties are superior to the subject, an amount is subtracted from the sales price. Inferior features require that an amount to be added to the sales price. Differences that do not affect value are not adjusted.
4. Net Adjustment/Gross Adjustment – At the bottom of each comparable, you’ll find a Net Adjustment and Gross Adjustment. The Net Adjustment is the sum of positive and negative adjustments. This is the figure added or subtracted to the sales price of the comparable to determine the price. The gross adjustment is the total dollar amount of the adjustments for the comparable without regard to whether the adjustments are positive or negative. Gross adjustment is used to judge the reliability of the of a comparable (i.e. the more adjustments made, the less reliable the appraisal).
5. Market Value – At the bottom of the comparable section will be a market price. This is the market price of subject home based on prior comparable sales. In other words, this is how much you should be able to sell your home.
6. Cost Value – Cost value may also be provided, depending on the appraiser and mortgage company you are using. The Cost Value defines the replacement cost of your home.  Market value is still the primary number used.
7. Remaining pages – Remaining pages may have supplemental pages where additional detail about the home and/or comparable properties is provided. They may also contain additional comparable properties.

How your underwriter uses the appraisal

If you’re like me, you probably wondered beyond just making sure the house is worth more than you are borrowing, what other qualifications do you loan underwriters look for. Here are just a few things I found in my research:

• Land value of the property shouldn’t exceed 35% of the total value except in extreme locations.
• Sales comparison approach. This is where the appraiser uses “comps”. Appraisers adjust comps for variations from the subject property. Wild fluctuations or huge adjustments are red flags.
• Lenders expect an appraiser to “bracket” the subject property with adjusted vales (one higher, one lower than the subject)
• Comparables should be “closed” transactions within 6 months of the appraisal date and within one mile of the subject property. Deviations should be well explained in the commentary.
• Cost approach should be relatively close to the  sales comparison approach in value. Take note, the improvement value is what is used to determine fire insurance coverage.
• Market analysis: declining values or declining areas always promulgate further review. Stable or rising values are always favorable.