Financing Residential Real Estate
Lesson 9:
Qualifying the Property
Introduction
In this lesson we will cover:
a lender’s perception of value,
appraisal standards,
the appraisal process,
appraisal methods, and
how to deal with low appraisals.
Lender’s Perception of Value
In addition to qualifying the buyer, underwriter must
qualify the property being purchased.
Is the property worth enough to serve
as collateral for the loan?
Lender’s Perception of Value
Appraisal
Evaluation of property for underwriting purposes is
based on an appraisal.
Appraiser analyzes property and issues
objective estimate of its market value.
Lender’s Perception of Value
Market value
Widely accepted definition of market value:
“The most probable price which a property
should bring in a competitive and open
market under all conditions requisite to
a fair sale, the buyer and seller each
acting prudently and knowledgeably, and
assuming the price is not affected by
undue stimulus.”
Lender’s Perception of Value
Appraised value and loan-to-value ratio
Lender uses property’s appraised value to
determine how much money to loan with the
property as security.
Loan-to-value ratio expresses relationship
between loan amount and property’s value.
Lender’s Perception of Value
LTV and risk
LTV affects:
Risk of default
Lender’s Perception of Value
LTV and risk
LTV affects:
Risk of default
Lower LTV = larger downpayment
Borrower with large investment less likely
to default.
Lender’s Perception of Value
LTV and risk
LTV affects:
Risk of default
Lower LTV = larger downpayment
Borrower with large investment less likely
to default.
Risk of loss in case foreclosure required
Lender’s Perception of Value
LTV and risk
LTV affects:
Risk of default
Lower LTV = larger downpayment
Borrower with large investment less likely
to default.
Risk of loss in case foreclosure required
Sale proceeds more likely to cover debt.
Lender’s Perception of Value
LTV and risk
LTV affects:
Risk of default
Lower LTV = larger downpayment
Borrower with large investment less likely
to default.
Risk of loss in case foreclosure required
Sale proceeds more likely to cover debt.
Lower LTV = Lower Risk
Lender’s Perception of Value
LTV and cost of loan
Lenders tend to charge higher interest rates and
loan fees on high-LTV loans.
Offsets additional risk for lender.
Lender’s Perception of Value
Maximum loan amount
Lenders use LTVs to set maximum loan amounts.
Maximum LTV rules applied depend on
type of loan.
Lender’s Perception of Value
Maximum loan amount
Maximum loan amount for transaction based on:
 sales price, or
 appraised value,
 whichever is less.
Appraisal Methods
Three ways to appraise real estate:
sales comparison method,
replacement cost method, and
income method.
Appraisal Methods
Sales comparison method
Sales comparison method uses sales prices of
comparables to estimate market value of subject
property.
 Preferred by appraisers.
Sales Comparison Method
Sales comparison appraisal vs. CMA
Competitive market analysis (CMA) is informal
version of sales comparison method of appraisal.
 Used by real estate agents.
 May use current and expired listings as
well as sales.
Appraisal is based on actual sales, not listings.
Sales Comparison Method
Identifying comparables
Appraiser needs at least three good comparables.
Sales Comparison Method
Identifying comparables
Appraiser needs at least three good comparables.
In choosing comparables, appraiser concerned with:
date of sale,
location of property,
physical characteristics of property,
terms of sale, and
conditions of sale.
Identifying Comparables
Date of sale
More recent comparable sales provide more
accurate reflection of current marketplace.
Identifying Comparables
Date of sale
More recent comparable sales provide more
accurate reflection of current marketplace.
Sales should be within past six months.
And if more than a few months old, may
require adjustment for area price trends.
Identifying Comparables
Date of sale
More recent comparable sales provide more
accurate reflection of current marketplace.
Sales should be within past six months.
And if more than a few months old, may
require adjustment for area price trends.
In slow market, may have to use sales more
than six months old and make adjustments.
But never more than a year old.
Identifying Comparables
Location of sale
Comparables should be from neighborhood where
subject property is located.
Identifying Comparables
Location of sale
Comparables should be from neighborhood where
subject property is located.
If there aren’t any, appraiser can look elsewhere, in
comparable neighborhoods.
 Make appropriate adjustments.
Identifying Comparables
Physical characteristics
Comparable property should have physical
characteristics similar to those of subject property.
To indicate value of subject property, comparable’s
price adjusted:
Identifying Comparables
Physical characteristics
Comparable property should have physical
characteristics similar to those of subject property.
To indicate value of subject property, comparable’s
price adjusted:
down if subject lacks feature;
Identifying Comparables
Physical characteristics
Comparable property should have physical
characteristics similar to those of subject property.
To indicate value of subject property, comparable’s
price adjusted:
down if subject lacks feature;
up if subject has extra feature.
Identifying Comparables
Terms of sale
Appraiser must take into account influence terms of
sale may have had on price paid for comparable.
Buyer may pay more for property if seller
finances or pays points.
Identifying Comparables
Terms of sale
Appraiser must take into account influence terms of
sale may have had on price paid for comparable.
Buyer may pay more for property if seller
finances or pays points.
USPAP requires appraiser to state whether
market value estimate is stated in terms of:
 cash,
 cash-equivalent financing, or
 other precisely defined terms.
Identifying Comparables
Conditions of sale
A comparable reliably indicates value only if sale
took place under normal conditions:
sale between unrelated parties (arm’s length
transaction);
Identifying Comparables
Conditions of sale
A comparable reliably indicates value only if sale
took place under normal conditions:
sale between unrelated parties (arm’s length
transaction);
both parties:
free of unusual pressure,
informed of property's qualities,
acting in own best interests; and
Identifying Comparables
Conditions of sale
A comparable reliably indicates value only if sale
took place under normal conditions:
sale between unrelated parties (arm’s length
transaction);
both parties:
free of unusual pressure,
informed of property's qualities,
acting in own best interests; and
property on open market for
reasonable time.
Identifying Comparables
Conditions of sale
If subject property is REO, appraiser should use
only other REOs as comparables.
REO: property bank-owned after foreclosure
REOs usually less valuable than otherwise
similar properties, due to:
 vandalism and deterioration
 difficulties of institutional sales
Sales Comparison Method
Adjustments
Appraiser rarely can find three homes exactly like
subject property.
Must make adjustments to account for differences in:

time,

location,

physical characteristics, or

terms of sale.
Sales Comparison Method
Adjustments
The more adjustments necessary, the less reliable
the comparable is as an indication of subject
property’s value.
Sales Comparison Method
Reconciliation
Appraiser selects estimate of subject property’s
value from within range established by adjusted
selling prices of comparables.
This process is called reconciliation.
Sales Comparison Method
Market conditions
For most residential properties, appraiser must
complete Market Conditions Addendum to the
Uniform Residential Appraisal Report.
Addendum gives lender picture of local housing
market.
Summary
Sales Comparison Method
Comparable sales
CMA
Date of sale
Location
Physical characteristics
Terms of sale
Conditions of sale
Adjustments
REO
Market Conditions Addendum