Property sellers often ask professionals who are performing appraisals for mortgage lending, “Why is an appraisal even needed? The buyer and I have already agreed on a sale price.” However, when it comes to appraised value vs. sale price, they are not the same thing.
To a layperson, requiring an appraisal seems a bit strange. After all, if they buy a car and finance it through a lending institution, the financing is simply based on the sale price of the car without the need for an appraisal.
Real property is different, though. In most cases, a mortgage lender will require an independent third party (i.e., an appraiser) to value the property to affirm its suitability as collateral for a mortgage loan. Value and sale price are meaningfully different concepts.
What is Value?
Value is defined in the Uniform Standards of Professional Appraisal Practice (USPAP) as:
“The monetary relationship between properties and those who buy, sell, or use those properties, expressed as an opinion of the worth of a property at a given time.
Comment: In appraisal practice, value will always be qualified—for example, market value, liquidation value, or investment value.”
As indicated in the definition, there are many different types of value. While these value types differ, they have one thing in common—they are all opinions. In most mortgage lending appraisal assignments, the type of value sought is market value. Federal banking regulations define market value as “the most probable price which a property should bring in a competitive and open market under all conditions.”
What is Sale Price?
Unlike value, price is not an opinion. It is a fact. Price is defined in USPAP as:
“The amount asked, offered, or paid for a property.
Comment: Once stated, price is a fact, whether it is publicly disclosed or retained in private. Because of the financial capabilities, motivations, or special interests of a given buyer or seller, the price paid for a property may or may not have any relation to the value that might be ascribed to the property by others.”
What’s the Difference Between Sale Price and Appraised Value?
The comment in the definition of price clearly delineates the difference between price and value.
If a property is under contract for purchase at $450,000 and an appraiser provides a market value appraisal of $425,000 for the property, the $450,000 sale price is a fact, while the $425,000 appraised value is the appraiser’s opinion. The $450,000 price is what the property is actually selling for. The $425,000 market value opinion is what the property should sell for, under the specific conditions of the definition of market value.
The concepts of price and value are not totally unrelated. Appraisers use sale prices (i.e., facts) when developing value opinions. For example, in the sales comparison approach, an appraiser will use the sale prices of similar properties in the market area to develop and support their opinion of market value.
The Appraiser’s Role
Properties don’t always sell for what they should. Depending on many factors, including the motivations and negotiating skills of the parties involved, a property might sell for more than its value, less than its value, or right at its value.
Mortgage lenders engage appraisers to provide value opinions that help them determine how much money can be safely loaned on a property. In most lending situations, the lender is the appraiser’s client, even though the borrower might ultimately be paying the appraiser’s fee. The appraiser owes a duty of confidentiality to the lender and is not permitted to discuss the appraised value with anyone else, including the borrower.
Generally, the lender will loan a certain percentage of the appraised value or the sale price, whichever is the lower amount.
- Example A: A borrower applies for a 90% loan on a property that is selling for $500,000. The appraiser values the property at $510,000. In this case, the lender will lend 90% of $500,000, which is $450,000.
- Example B: A borrower applies for a 90% loan on a property that is selling for $500,000. The appraiser values the property at $480,000. In this case, the lender will lend 90% of $480,000, which is $432,000.
When the appraised value is lower than the pending purchase price, it can be problematic for everyone involved. The buyer and seller could agree to lower the sale price to the appraised value, the buyer may need to come up with additional down payment funds, or the parties could cancel the sale altogether. This is not fun for anyone. And often, the parties direct their ire at the appraiser.
It is important to note that appraisers are required by USPAP to be independent, impartial, and objective when performing appraisals. An appraiser is not part of the lender’s team. It is not the appraiser’s job to make sure the borrower gets the loan. If an appraiser intentionally manipulates the appraised value to meet the lender’s (or borrower’s) objectives, that appraiser has violated the ETHICS RULE of USPAP, which states, in part:
“An appraiser must perform assignments with impartiality, objectivity, and independence, and without accommodation of personal interests.”
Most appraisers are reluctant to manipulate appraised values to meet sale prices, with good reason. An appraiser who violates the ETHICS RULE is subject to discipline by the state appraisal regulatory agency. They could face monetary fines, suspensions, and/or revocation of their appraiser credential.
Beyond Appraised Value Vs. Sale Price
Now that you understand the difference between appraised value and sales price, there’s so much more to learn. If you are ready to discover more about the appraisal profession and its benefits, check out McKissock’s appraisal career guide. Download your free copy to help you unlock your path to a new and rewarding career in real estate appraisal. Or, visit McKissock.com/Appraisal to learn how to get licensed in your state.
