How the Appraisal Process Can Derail Your Mortgage Approval

Could an appraisal undermine your efforts to get a mortgage loan?

When you apply for a mortgage loan, many factors affect if you'll be approved and how much you can borrow. These include your income, credit score, and down payment. But they also include something completely out of your control: your home appraisal.

Lenders require an appraisal so a professional can determine what the home is worth. They want to make sure the home is valued highly enough that it can serve as sufficient collateral to guarantee the loan. Unfortunately, if your appraisal comes in too low, you could end up not being able to borrow the amount you need for the home you want to buy.

How an appraisal could affect your ability to get a home loan

Mortgages are secured loans, and the home needs to be worth enough so the lender doesn't face financial loss if they have to foreclose.

In fact, lenders generally prefer that you make at least a 20% down payment so that they aren't loaning you the full value of the home. While you don't necessarily have to do this, you'll generally end up paying for private mortgage insurance (PMI) if you put down less than 20%.

The amount you can borrow, relative to what the home is worth, is called the loan-to-value ratio. But the appraisal of the home -- not necessarily the amount you're paying for the home -- determines the "value" when your loan-to-value ratio is determined.

For example, say you offer $400,000 on a home you like, and you plan to make an $80,000 down payment. If the home is appraised for $400,000, you'd have an 80% loan-to-value ratio and wouldn't have to pay for PMI.

If the appraiser determines the home is worth just $350,000, though, you have a problem. If you pay the $400,000 you offered and put down $80,000 as planned, you'd be borrowing $320,000 to buy a home that the lender views as being worth just $350,000.

Your loan-to-value ratio in this case would suddenly be 91% and you'd have to pay PMI. And in some cases, if your loan-to-value ratio is too high, the lender may not want to give you a loan at all.

What to do if you end up with a low appraisal?

If your home doesn't appraise for as much as you expect it to, you have some options:

• Appeal your appraisal. You could ask the appraiser to take another look. It can sometimes lead to a higher appraised value, especially if you point out why some of the comparable properties the appraiser used weren't actually comparable or suggest alternative properties that could show your home is worth more.
• Try to get the loan anyway. If the low appraisal lowers your loan-to-value ratio, you may not be approved though. Or you may end up being approved but be forced to pay PMI.
• Make a larger down payment. In our example above where you offered $400,000 and the home appraised for only $350,000, you could put down extra money to make up the difference.
• Renegotiate your contract with the seller. If you made an offer contingent on securing financing and you can't get approved for a loan because of the low appraisal, you'd be able to walk away from the contract. You could use this as leverage to try to renegotiate the price. The seller may be willing to accept a lower offer if the appraisal is accurate and its value is truly lower than the offer since they'd otherwise be likely to run into this issue again.
• Walk away from the purchase. But if you don't have a clause in your offer contract allowing you to do this, it could mean forfeiting your earnest money.
• Apply for financing with a different lender. The new lender will likely want their own appraisal done, and it could come in higher. This is a risky strategy, though, because you'll have to pay for another appraisal and could find yourself in the same situation again. But you could look for a new lender that might allow a higher loan-to-value ratio, so you'd still end up closing on the loan even if the appraisal comes in low again.

Obviously, ending up with a low appraisal isn't ideal. But you do have options if this happens. You just need to make sure to explore them ASAP to overcome this big bump in the road to homeownership.