This article is based on the personal experience of the author, who is not a legal or tax professional, and does not reflect the views or opinions of Lennar Corporation or its affiliates. It is not intended to provide any tax or legal advice, and you should consult your own accounting, legal, and tax advisors for more information about the appraisal and tax assessment of your home or any property you consider for purchase.
If you are in the market to buy, or you recently purchased a new home, chances are you have heard of an appraisal, most likely from your mortgage lender. Simply put, an appraisal is a valuation of property, and an appraised value is an estimation of a property’s value at a given point in time. My recent experience as a first-time homebuyer taught me there are actually two appraisals: the first is for the purpose of securing your loan prior to your purchase, and the second is used by the local taxing authority to determine how much you will pay in property taxes – this is often called a “tax assessment.” I was initially confused about the difference between the two, so I took the time to research and wrote this article to hopefully resolve any confusion other homeowners may feel.
What is the appraisal in a home purchase?
For most, a home purchase requires taking out a mortgage with a bank or other lending institution. The lender wants to protect its investment, so it typically orders an appraisal of the property to determine if it is worth at least the amount the buyer is asking to borrow. (In other words, a lender wants to ensure that it does not lend more than the property is worth.) This is important because, should you enter a mortgage agreement, your new home serves as collateral for the loan. If you later default on your mortgage and enter foreclosure, the lender may resell your home to recover its investment.
The cost of this appraisal varies and usually comes out of your own pocket. You should check with your lender for precise costs. This charge will likely appear in your closing costs. It may seem an inconvenient expense, but appraisals can actually afford you security and even leverage. As a buyer taking on the expense of a home, you should want to feel certain that you are paying a fair price on a home where you will live for the next several years. Appraisals can reveal if the property is worth less than the seller’s asking price. In that case, you can either walk away and save your money (as long as you have an appraisal contingency), or you can try to renegotiate the price with the seller. Look for the appraisal contingency in your purchase agreement which protects you if you want to abandon the sale and sometimes refunds your earnest money to you.
So, how does the appraiser determine the value of the property in question? They start by visiting the home to evaluate its condition and quality of construction. Neither you nor the seller needs to be present for this, but you can be there to learn the process more in depth if you like. The appraiser will look over the exterior and interior of the home, noting its square footage, number of bedrooms and baths, homesite size, parking, and zoning. They mark up any issues and special features that respectively detract and add value to the home’s market price. Other factors in the valuation include the home’s age, curb appeal, and recent repairs and improvements. Anything that is not affixed to the property, like décor and furniture, is not considered. This visit can take anywhere from 15 minutes to a couple hours, depending on the size and state of the home. It is not to be confused with a home inspection.
In addition to their visit, the appraiser researches the neighborhood and surrounding area. They pay attention to local issues and proximity to schools, hospitals, and amenities. Sources of noise pollution, like a nearby airport or train tracks, and other detractive influences are noted. More importantly though, the appraiser should review current market trends and comparable properties (or comps) that are very similar to the home they are appraising. These comps should be located in the same neighborhood as the property being appraised and have sold in recent months. Their sales prices provide a dollar range, and the appraiser adds or subtracts those unique features between the comps and your potential home to arrive at a fair market value.
Typically, the appraiser’s report will be available in less than a week. If they estimate the home is not worth the asking price, but you still wish to pursue the sale, your lender will probably lend no more than the appraised value, and as a result, will likely require you to pay the difference between the asking price and the appraised value. That means you will probably have to put more money toward the down payment than was originally discussed, because no lender will give more than the maximum LTV, that being the loan-to-value ratio. This financial term expresses the ratio of how much of a loan you will get in relation to how much the property is valued.
What is the appraisal for property taxes?
One of the most taxing responsibilities as a homeowner is paying property taxes – bad pun intended! Property taxes help pay for local services including the police, fire departments, road maintenance, sanitation, hospitals, public schools, libraries, parks and other recreation. The county or other jurisdiction in which your property is located will issue an appraisal (sometimes called a “ tax assessment” in this context) of your home to determine its tax assessed value. That value is then used by local taxing authorities to determine what you will pay in property taxes.
This type of appraisal can occur annually or, since the county pays for it, every three to five years. In addition to periodic assessments, most jurisdictions will reassess a property at the time of sale. Many jurisdictions use one of three approaches to assess a property: (1) sales comparison approach, (2) income approach, and (3) cost approach. I will highlight the sales comparison approach, since it is the most commonly used and was used to assess my own property.1
Similar to the appraisal for a home purchase, under the sales comparison approach, the appraiser identifies comps for properties similar to your own that sold in the last six to twelve months and are located in the same geographic area. He or she compares the age, size, condition, and quality of construction, and notes any known repairs or improvements, before estimating your property’s market value. (Market value is just another way of saying how much your property would sell for if you were to sell it on the open market.) Depending on where you live, the market value may not be the same as the tax assessed value. Some states use 100% of the market value to determine how much a homeowner will pay in property taxes. Other states use an assessment rate that is a percentage of the market value. For example, in a state with an assessment rate of 80%, a home with a market value of $182,000 would have an assessed value of $145,600. The higher the assessed value, the more you will typically pay in property taxes.
One issue with this type of appraisal is, unlike the one ordered by a lender for a home purchase, the appraiser frequently does not visit your home or the comparable properties to complete their assessment. Instead, they often pull information from an online multiple listing service (MLS), and this in turn introduces the possibility of mistakes, such as misinterpretation or the complete oversight of relevant details. The appraiser may not be aware of damages, repairs, improvements or renovations done to your home or the comps that can impact their market values. If you believe your property has not been properly assessed, you may have the opportunity to protest the tax assessed value of your home. This in turn may permit you to pay a lower amount in property taxes. You can learn more about the steps to protesting your tax appraisal here.
I hope this article has resolved any confusion you may have had about these two appraisals. I encourage you to speak with a legal or tax professional, or even an appraiser, about the subject matter discussed here so as to gather more information and assistance making decisions on the individual facts and circumstances surrounding your own property. Additional resources for your own reading are found below.
On the appraisal for a home purchase…
On the appraisal for property taxes…
On the difference between them…