04 Mar 2018

It’s time we talk about appraisals again especially in light of this pretty awful story I found online about this couple who is complaining that the house they bought is now priced lower.

This is the story that ran on CBC news.

Because, you know, house prices should never fall, right?

There are many things that are very wrong with this whole story but I want to address one of the biggest things that will probably go wrong for these people when it is time to close on their home – hopefully to shed some light on appraisals and how they are very relevant in this topsy-turvy market we seem to be in.

When you are buying a property from a builder or a resale, you’re buying at what you think the property is worth at that time. This can be based on comparables, of course, and it usually should be. A house with 3 bedrooms and 2 baths, should be priced similar to another house of equal finish. When you’re buying a pre-construction property however, the common thought is that you’re either getting a deal or at least buying it for its future value since it’ll take potentially years to realize. And we have all seen that property values have steadily increased over years, so we’ve all heard of that friend who made off like a bandit waiting and realizing many gains at closing artificially if they didn’t sell, and real gains if they did.

So now let’s take X and Y. They bought a house pre-construction from the builder before the development was even started. They thought for sure they’ll end up with a higher value. They were, unfortunately, wrong. Same houses in the same development about a year later are selling for $90,000 less. So now what? Now we wait and see what happens to the market.

(By the way I love what the President of the company said about this: “ Just like the buyers are extremely happy in a rising market, they have to appreciate that the same decision could go the other way,”)

Fast forward to closing time and here’s where this will get interesting. IF values are flat from today to closing, these people will have a shortfall on appraisal because any appraiser who values their certification (and wants to keep a job) will not be able to get their appraisal up to the original purchase price since new(er) homes are selling for $90,000 less. So, what’s the buyer to do?

Here are their options as of today’s lending guidelines.

If they intend on putting down only 5% on closing then there’s no real nice way of putting this other than to say – they are absolutely screwed. For pre-construction purchases it is extremely rare to be allowed to just put down 5% – however – maybe they borrowed money from friends/family for the deposit and intend on just doing 5% on closing.

Let’s assume the house is $700,000. The minimum down payment is 5% on the first $500K and 10% on the remaining – $200K in this house – therefore $25K plus $20K = $45K.

Therefore their goal is to finance $700K – $45K = $655K (plus CMHC insurance of 4%)

But the value is $90,000 less, so now, there is a shortfall of (655-610=$45K). Ouch. They will need to find this money AND still finance 95% of the $610 appraised value. This won’t be easy.

If they will have 20% of their own money then they aren’t screwed but they might be. They can only take 25-year amortization not 30-year, so qualifying might be harder (although the current stress tests apply to ALL down payment). Still, assuming income and credit are strong, They have $140,000 on $700,000 = 20%, and now, they will have to “buy” for $610,000, and put down $50,000, and use the remaining $90,000 to pay for the difference. Now they have CMHC fees to deal with, but they still get to keep their house.

If they are putting MORE than 20% and that difference is enough to cover the $90,000 shortfall, and they still have enough for 20% down on the new price, they are more than okay. $610,000 at 20% down is $122,000 plus the $90,000 difference so they would need at least $122+90=$212,000 in total down payment to be void of any problems.

Appraisals are one of the biggest pain-points of buying and selling real estate. There are many types of appraisals involved including CMHC auto-appraisals where they don’t send an actual person to validate the property but rather do an internal valuation to old-school bank appraisals where someone is sent out independently of the lender and validates the property. In this pre-construction story I’m using, it highlights perfectly how these two buyers may have an appraisal problem unless the market does a rebound and prices go back to their original buying levels. How likely is that? Who knows. The problem with hoping for best-case scenario can lead to a hopeless situation at the end. The best course of action is to engage with a mortgage broker who knows the market they are buying in and who can guide them with that appraisal problem which they are almost for sure about to encounter.

Speak to me to learn how I have saved many people from the depths of appraisal hell and if you are facing a similar issue, or have any questions about appraisals, I’m here to help.


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