FHA V. Conventional Mortgage and Appraised Value Issues

Are you obtaining an FHA or a Conventional Mortgage? While an FHA insured mortgage may cost more and requires an up-front and monthly Mortgage Insurance Premium Payment (MIP), it also allows a borrower to pay less closing costs than with a standard conventional mortgage.

Another important difference between an FHA insured mortgage and a conventional mortgage is the FHA Amendatory clause. There is a common misconception that if the house does not appraise for the contract sales price, the purchaser will not have to complete the purchase unless the seller agrees to reduce the price. This is not correct. Think about it – if that were correct, the reverse should be true – if the house appraised for more than the sales price, the purchaser should agree to pay more for the house.

The reality is that in an FHA insured mortgage, the FHA Amendatory clause requires that if the property does not appraise for at least the contract sales price, the seller has the option to either reduce the sales price to the appraised value or cancel the transaction (unless the parties can agree on a compromise). In a conventional loan, the amount that your lender will lend is based on the principle of loan to value (LTV). They will only lend a percentage of the appraised value. As an example, suppose your seller has agreed to sign a contract where you are obtaining a mortgage of 80% of the purchase price. If the lender is willing to lend up to 80% LTV and the contract price is $100,000, the most the lender will give you is $80,000. If the appraisal comes in at $95,000, the lender would reduce the loan amount to $76,000. In this example, the lender will now only give you $76,000 and you would not have to complete the purchase unless the seller agreed to reduce the price (or you agreed to increase your out of pocket payment). However, in the same example, if you were only applying for a mortgage of $50,000 and your lender was willing to lend up to 80% LTV, your lender would still be willing to give you $50,000 to buy the property even at an appraised value of $95,000 because the original $50,000 you agreed to borrow is still less than the maximum LTV your lender would be willing to lend ($76,000 in this case). As a result, in a conventional loan, a lower appraised value does not necessarily allow a buyer to rescind a contract just as a higher appraised value does not mean that the seller would have the right to ask for an increase in the price.

A final word about appraisals. It is understandable that a buyer does not want to pay more for the house than it is worth (just as a seller does not want to sell for less than market value). Unfortunately, many buyers do not fully understand the concept of how the appraised value, loan to value, and sales price interplay. Ultimately, an appraisal is only an appraiser’s opinion of the value based on comparable sales, condition of the property, etc. Therefore, your decision should not be based solely on the appraisal. As a mortgagor, you will receive a tax deduction on the interest that you pay throughout the life of the loan. You will also be building equity in the property with every payment. Finally, as the average homeowner remains in a house for approximately 7 years, it is highly likely that you will realize a profit when you sell. Therefore, if the appraisal is lower or higher than the contract sales price, the buyer should consider all facts before deciding whether or not to complete the purchase and not make a decision based solely on the appraisal.

July 11, 2018

Are you obtaining an FHA or a Conventional Mortgage? While an FHA insured mortgage may cost more and requires an up-front and monthly Mortgage Insurance Premium Payment (MIP), it also allows a borrower to pay less closing costs than with a standard conventional mortgage.

Another important difference between an FHA insured mortgage and a conventional mortgage is the FHA Amendatory clause. There is a common misconception that if the house does not appraise for the contract sales price, the purchaser will not have to complete the purchase unless the seller agrees to reduce the price. This is not correct. Think about it – if that were correct, the reverse should be true – if the house appraised for more than the sales price, the purchaser should agree to pay more for the house.

The reality is that in an FHA insured mortgage, the FHA Amendatory clause requires that if the property does not appraise for at least the contract sales price, the seller has the option to either reduce the sales price to the appraised value or cancel the transaction (unless the parties can agree on a compromise). In a conventional loan, the amount that your lender will lend is based on the principle of loan to value (LTV). They will only lend a percentage of the appraised value. As an example, suppose your seller has agreed to sign a contract where you are obtaining a mortgage of 80% of the purchase price. If the lender is willing to lend up to 80% LTV and the contract price is $100,000, the most the lender will give you is $80,000. If the appraisal comes in at $95,000, the lender would reduce the loan amount to $76,000. In this example, the lender will now only give you $76,000 and you would not have to complete the purchase unless the seller agreed to reduce the price (or you agreed to increase your out of pocket payment). However, in the same example, if you were only applying for a mortgage of $50,000 and your lender was willing to lend up to 80% LTV, your lender would still be willing to give you $50,000 to buy the property even at an appraised value of $95,000 because the original $50,000 you agreed to borrow is still less than the maximum LTV your lender would be willing to lend ($76,000 in this case). As a result, in a conventional loan, a lower appraised value does not necessarily allow a buyer to rescind a contract just as a higher appraised value does not mean that the seller would have the right to ask for an increase in the price.

A final word about appraisals. It is understandable that a buyer does not want to pay more for the house than it is worth (just as a seller does not want to sell for less than market value). Unfortunately, many buyers do not fully understand the concept of how the appraised value, loan to value, and sales price interplay. Ultimately, an appraisal is only an appraiser’s opinion of the value based on comparable sales, condition of the property, etc. Therefore, your decision should not be based solely on the appraisal. As a mortgagor, you will receive a tax deduction on the interest that you pay throughout the life of the loan. You will also be building equity in the property with every payment. Finally, as the average homeowner remains in a house for approximately 7 years, it is highly likely that you will realize a profit when you sell. Therefore, if the appraisal is lower or higher than the contract sales price, the buyer should consider all facts before deciding whether or not to complete the purchase and not make a decision based solely on the appraisal.