RealAnswers

A reader asked, “What is the difference between purchase price, appraised price and loan amount?” in a real estate transaction.

The purchase price is simply the price agreed between buyer and seller.  It’s the amount that the seller will receive once the seller’s closing costs are paid. It’s the amount that the buyer will pay at closing, including any loan.  Purchase price is the “top line” in any real estate transaction.   In a cash transaction, the purchase price is all there is to worry about – there would be no loan (the loan amount is zero) and with no loan there’s no need for an appraisal.

The second part of the question, appraised price, is actually a bit of a mistake.  There’s no such thing as “appraised price”.  Instead, there’s an appraised value.  Appraised value is the estimate of the value of the property arrived at by a licensed appraiser using standardized valuation methods including analysis of comparable sales, cash flow. Fannie Mae defines the appraised value as “An opinion of a property’s fair market value, based on an appraiser’s knowledge, experience, and analysis of the property. “  Some of us would argue that the purchase price is the only true measure of value – the price that a willing buyer and a willing seller agree to in an arm’s length transaction – and that appraised value should be called something else.  The appraisal is a tool used by the bank to determine a safe amount to loan against the house or at least to keep the loan risk in an acceptable range.  Which brings us to…

The loan amount.  The loan amount will be a certain percent of the value of the house, depending on the loan type.  The “standard” conventional mortgage is an 80% loan-to-value, though this can be as high as 100% with mortgage insurance.  This means that for this type of mortgage, the bank will loan $80 for every $100 of “value”.  And what is value – it’s the lower of the purchase price or appraised value.  So, for example, if a house has a purchase price of $100,000 and an appraised value of $90,000, the maximum loan amount on an 80% loan is $72,000.  For a house with a purchase price of $100,000 and an appraised value of $120,000, the maximum loan amount on an 80% loan would be $80,000.  It doesn’t matter which number is higher, the bank always considers the lower number as the true “value”.

There are two common reasons that people ask for clarification on these three numbers.  One is when a buyer sees that the house appraised for less than purchase price or the seller sees that it appraised for more.  The buyer or seller may want to know if they are entitled to pay less or be paid more.  Generally, the answer is no.  The appraisal is a tool for the bank and the “value” it determines is based on standard formulas.  The price you as buyer or seller agreed on is determined by the wants and needs of both parties and that isn’t something the appraiser could necessarily quantify or even something the appraiser should ethically consider if he could.  The appraised value does not, unless agreed by both parties, obligate either buyer or seller to adjust the purchase price.   In fact, houses usually do sell for an amount different from the appraisers estimate of value.

The second reason this question gets asked is that buyers, especially new investors, often hope that a higher than purchase price appraisal will allow them to borrow more than the purchase price for repairs or to make a smaller down payment.  Generally, the higher appraisal won’t allow either of those.  Since the loan amount is based on the lower of the appraised value or purchase price, a higher appraisal doesn’t make any difference.  The lower number is always the one used to set the maximum loan amount – if the appraisal is higher, the purchase price sets the maximum loan; if the purchase price is higher, the appraisal sets the maximum loan.  The bank protects itself with the most conservative value either way.  There are, of course, specialized loans that allow borrowers to receive money for repairs and loans that require little or no down payment, but it’s not necessary for a house to appraise above purchase price to use those loans and an above purchase price appraisal won’t be any help with a conventional loan.

Technorati Tags: purchase price, appraisal, appraised value, loan amount, mortgage