Refinancing: The Risks of Mis-Appraised Properties

Is your appraisal way too high? Way too low?

If your appraisal is too high, you might be assuming a mortgage from which there is no escape, and you may not be able to sell your property in the future. If your appraisal is too low, someone essentially may be stealing your property. Additionally, a low appraisal might mean that you will not be granted a mortgage unless you can pay the cash difference (or take out a second mortgage) between the appraisal and the asking price. Obtaining an accurate appraisal is critical.

High Appraisals

According to most national housing market studies, most homes have been properly appraised – good news! If the housing market cools off, however, people - especially those with the nicest homes closest to market appraisal – may be forced to lower their price to sell. This is what occurred in California in the early 1990s.

In such a scenario, homes with prices near the middle of the market are less competitive than usual, and the people most likely to be financially hurt in a buyers’ housing market fall into two groups: (1) those who took home equity way over fair market appraisals; and (2) those who were planning on high resale values.

My advice is to set your own limits in terms of new appraisals. If you bought your home for $150,000, for example, then be realistic about how much you think it has been increasing in value each year (10% per year would be a good return). Consequently, if an appraisal comes back three years later at $250,000, this probably is too high. Instead of trying to get $100,000 out of your property, it would be safer to think of the house as having increased only by $45,000 (or $15,000 per year). Again, this simply is a way of using your own equity as savings when interest rates are uncertain.

None of this means, however, that having bought a home was a bad decision. It simply means that you always need to be cautious about how you spend equity. No matter how high an appraisal you receive, you should try to keep at least 20% equity in your home. This is particularly true nowadays when interest rates are showing fluctuation, and probably will continue to do so into 2008.

Being “upside down” in a house, or owing more money than the value of the property, can happen when an appraisal is too high. It is crucial to remember an important rule of economics: money is always more expensive now than it will be next year. By taking equity out now, you may essentially already have ‘sold’ your home – which is fine as long as your spend the money wisely.

After the period of poor performance in the California real estate market, the market rebounded strongly. If you have taken the full equity value from an overly-high appraisal, simply hang around for the market to take a turn for the better.

Low Appraisals

Worst of all issues concerning appraisals is what is known as ‘redlining’. Historically, redlining was used to cheat minorities. Financial institutions strategically would draw a red line on a map, and everything inside the red line would be undervalued. Mortgages would not be given to minority consumers who resided within, or else they would be given at absurdly high rates or purchased for obscenely low costs. Redlining now is illegal, but the argument continues that it still exists in economic practices such as appraisals.

Similar predatory practices may try to force low-income homeowners out of their homes. If you feel you have been unfairly taken advantage of, contact your state attorney general and make a complaint. Almost every state has a consumer affairs division, and most have mortgage protection laws. A few states even have divisions to investigate sham appraisals or predatory lenders. For general help in locating appraisal professionals, especially in urban locations, write to:

National Association of Real Estate Brokers
1629 K Stree NW
Washington, D.C. 20006

If you have gotten a low appraisal, get a second or even third opinion before implementing expensive remodels into your home. It is heartbreaking to see someone take all the equity from their home, especially when they expect to increase the value, and end up with the shock of another low appraisal. In fact, most remodels only give back 70% of their costs in the short-term.

The risk of mis-appraised property can be devastating, so ensure that your appraisal is accurate and that you subsequently act in your best interest. The American dream of home ownership reminds us that we all are in this economy together: today’s buyer is tomorrow’s seller. Be smart at both!