If You Plan to Buy or Sale a House, You Must Read This!

One of the biggest concerns both buyers and sellers of houses have in today’s market is the “value” of the house. If you currently own a home, or if you plan on buying a home, the information in this blog is very important to you. The value of anything is typically expressed as the price a willing buyer will pay and the price a willing seller will accept. In the current real estate world we all live in, “value” is all messed up! The concept of value in real estate has brought another player to the table, and this player has as much or more influence on the “value” of a piece property as the buyer and seller do. This new player is the lender. The lender’s influence creates many potential risks to both buyer and seller.

Prior to 2008, house values were rarely questioned by the lenders. They have always required an appraisal, but unless the contracted price of a house was completely outrageous, the property was almost always appraised at the purchase price or higher. After the housing bubble burst, lenders became much more interested in the value of their collateral, the house. In typical fashion, things moved from being very lax, to being overly conservative almost overnight. This has actually resulted in downward pressure on home values as lenders become more skittish and refuse to lend money on houses unless they are very comfortable with the value.

Enough of the brief history lesson. How can this new aggressive approach towards house values by lenders affect you as a seller or buyer? The challenges are similar for both parties in the transaction. You need to be informed as to what you can do if an appraisal comes in low; you need to know what the lender may choose to do with an appraisal and you need to understand the implications on your purchase and sale contract.

If you plan to buy or sale a house, keep these things in mind:
1. Most real estate purchase and sale contracts have something called contingencies written into the contract. Most real estate agents will recommend to both the buyer and seller 3 different contingencies; a lender approval contingency, an inspection contingency and an appraisal contingency. If the buyer is approved by the lenders underwriter to get the loan, the lender approval contingency is removed. The buyer then completes a satisfactory inspection (and the seller agrees to make any repairs) and this removes the inspection contingency. Finally, the house appraises for at least the agreed upon sales price and the appraisal contingency is removed.
2. Once these (or any other agreed upon) contingencies are satisfied, the buyer is obligated to buy and the seller is obligated to sell the property at the agreed upon terms. All parties of the transaction think they are protected, but that is not the case. The seller is still exposed IF the lender decides on their own to research the value of the house beyond the appraisal the lender ordered. Lenders can use something called an Auto Valuation Model (AVM) to perform their own independent review of the property value. If the lender decides the AVM indicates a lower value than both the appraisal AND the sales price, the lender can lower the approved loan amount for the buyer. If this happens, and a contingency for this situation is not written into the contract, the seller is obligated to buy the house anyway, and must come up with the difference out if his own pocket. If the buyer refuses to buy the house, they will lose all earnest money, which will be forfeited to the seller. The buyer may also face expense claims from his agent’s broker as well. YOU MUST PROTECT YOURSELF AS A BUYER BY HAVING A CONTINGENCY FOR ANY LENDER INDUCED VALUATION CHANGES. MOST REAL ESTATE AGENTS ARE NOT AWARE OF THIS AND WILL NOT TYPICALLY INCLUDE IT IN YOUR CONTRACT.
3. Contrary to urban myth, appraisals can be challenged. It is the right of the buyer (borrower), real estate agent and mortgage originator to call into question the accuracy of any appraisal. Many real estate professionals (and almost every appraiser) will tell you that “new” laws prevent any contact with the appraiser from the people listed above. The normal excuse is something called the Home Valuation Code of Conduct (HVCC). This policy was started by the New York attorney general to help combat mortgage fraud, and many of its provisions have been adopted by the lending industry. As with most new policies, miscommunication is rampant and some (non-existent) provisions suddenly become “the law”. The real law is the recently enacted Dodd-Frank financial reform bill that specifically permits appraisals to be challenged if there is a belief of an unreasonable valuation. There are strategies that can be used to more effectively challenge an appraisal, but this is another subject entirely.

The current real estate market is a challenge and many people falsely assume that lenders and appraisers have all the power. If you intend to buy or sell a house, it will pay for you to be educated and informed about the market and the process. Don’t assume your agent is aware of everything you need to properly protect your interests and has even read the contracts. If you do not understand something, you might want to discuss the deal and the documents with your own legal counsel. Money you spend to have an attorney review your contracts, and to recommend language to meet your deal objectives can be money well spent (and almost nobody does this!).

A home is the single largest expenditure the average American will ever make. Treat it that way and get the proper education and legal advice. Depending on agents, friends and family could cost you big money and lots of headaches!