Why A Lender Requires An Appraisal
Appraisal Basics
A real estate appraisal is a key component in a lender’s decision to lend. There are several purposes for completing a real estate appraisal, including to determine:
- The cost to rebuild the home in case of damage, such as by fire (insurable value)
- A value so that a municipality can apply its property tax rate (taxation purposes)
- The price that a real estate investor would pay for a property based on his or her preferred rate of return (investment value)
- The amount that the property can obtain if sold (selling price)
- The future value of a property under construction (future price)
- The value of a property being expropriated by the Crown (expropriation value)
- The market value of a property for a lender to decide on an appropriate loan amount for mortgage financing.
The process in determining value for each reason differs, since the value will differ based on the appraisal’s purpose. A lender requires an appraisal to be completed on a property to determine the market value of that property. In addition, an appraisal can provide several other pieces of vital information required to make an informed decision to lend. Since lenders will lend based on a LTV, the lender requires an exact estimation of value to determine the exact mortgage amount available.
Mortgage brokering in Ontario is regulated by the Financial Services Commission of Ontario (FSCO) and requires a license. To obtain a license you must first pass an accredited course. The Real Estate and Mortgage Institute of Canada Inc. (REMIC) is accredited by FSCO to provide the course. For more information please visit us at www.remic.ca/getlicensed or call us at 877-447-3642
The Appraiser
The appraiser is the accredited individual who completes the appraisal report. Although a license to conduct appraisals is not required in Ontario, no lender would use a non-accredited appraiser since the decision to lend will typically involve several hundred thousand dollars. The lender must be confident that the appraisal company employs appraisers who are educated in performing appraisals, have proven track records or are supervised by senior appraisers, follow ethical standards as set forth by the industry and are generally known to produce quality reports.
Several lenders will have their own list of approved appraisal companies. These are companies that they have dealt with in the past or who have been through an approval process by the lender that typically involves assessing the appraisal company to ensure that it meets the lender’s standards.
The Appraisal
An appraisal is a report produced by a designated appraiser that determines the market value of an interest in land using accepted valuation techniques based on the purpose of the appraisal for a specific client.
The client in most cases of mortgage financing is the lender, although the applicant typically pays for the appraisal report. It is an important distinction to make that the client is paying for the service of the appraisal being completed, while the lender owns the report.
The report will base the market value on the lender’s specific criteria and include details about the property that the lender may require. In certain circumstances, lenders will require a different emphasis on property characteristics, resulting in the appraisal report being acceptable to one lender while unacceptable to another.
If a lender declines the applicant’s request for financing and the applicant wishes to provide the appraisal to another lender, the appraiser must re-address the appraisal to the new lender and the new lender must be willing to accept it. This does not always occur since different lenders have different requirements.
The Value of a Property
It is important to distinguish between market value and price. Price is what may be paid for a property; however there are many reasons that the price paid for a property may be higher or lower than what someone else may pay for it. For example, if a purchaser is buying a house from a family member the price paid may be lower than the price would be if sold to a non-family member. In addition, a real estate investor may pay more for a property that he or she believes will provide a high return on his or her investment. A lender is interested in knowing what the market will pay for a property under normal circumstances. Therefore, the real estate appraiser must appraise the market value.
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Real estate property appraisals for mortgage financing
A mortgage lender is interested in knowing what the market will pay for a property under normal circumstances. A real estate appraiser will produce a document called an appraisal that calculates the market value of a property being used as security for a mortgage. Market value can be defined as:
The amount, in Canadian funds, for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing, where the buyer and seller have each acted knowledgeably, prudently, and without pressure.
There are three basic types of appraisal reports, ranging in scope from basic to highly detailed.
Desktop appraisal for mortgage financing
The desktop appraisal is typically used when an AVM is unavailable and the property is located in a marketable area. This report relies on MLS reports, including data on recent sales and data on recent listings. It does not provide detailed information on the property nor is there a physical inspection of the property, which raises the same issues as are applicable to AVMs.
Drive-by appraisal for mortgage financing
This type of appraisal is based on the same information as the desktop appraisal; however it also includes an inspection of the exterior of the property. While AVMs and desktop appraisals cannot provide details on whether the property is actually in a physical condition normal for the neighbourhood, a drive-by appraisal can at least indicate that the property’s exterior is typical or conforms to the neighbourhood. In addition the drive-by appraisal allows the appraiser to view and provide details on the neighbourhood, which is a key element in assessing the marketability of the subject property. The report typically contains exterior photographs of the property as well as the immediate neighbourhood.
If the drive-by appraisal results in the determination that the property appears to be in a condition that is not typical of the neighbourhood, a full appraisal should be completed.
Mortgage brokering in Ontario is regulated by the Financial Services Regulatory Authority of Ontario (FSRA – formerly FSCO) and requires a license. To obtain a license you must first pass an accredited course. The Real Estate and Mortgage Institute of Canada Inc. (REMIC) is accredited by FSRA (formerly FSCO) to provide the course. For more information please visit us at www.remic.ca/getlicensed or call us at 877-447-3642.
Full Appraisal for mortgage financing
A full appraisal expands on the information and techniques used in the desktop appraisal and the drive-by appraisal by having a full inspection of the subject property completed. This inspection allows the appraiser to document the characteristics of the subject property, including any upgrades or defects in the home. The report typically contains interior and exterior photographs of the property as well as the immediate neighbourhood. Considered to offer the most information and therefore the highest level of protection for the lender, the full appraisal is the appraisal of choice for lenders who rely heavily on the property as security and less on the personal covenant of the borrower. Virtually every sub-prime and private lender will insist on a full appraisal.
