Did the appraisal on your client’s home come in too low? Don’t panic your client does have some options.
First off, let that sinking feeling in your stomach subside. You and your Buyers have viable options. Your clients will be looking to you for direction. Provide it.
Begin by increasing your own understanding of the impact that any low valuation could have. If a Buyer has a significant down payment then the effect that a low property valuation has on the loan and its quoted interest rate may be slight or even nonexistent. If a Buyer is putting 50% down then the lender’s risk even if the property’s evaluation comes in considerably less than what the Buyer paid for the property, is no greater than had the valuation been at the selling price.
With a significant down payment the main consideration a Relator has is that the Buyer may feel that they have overpaid for the home. Handhold the Buyer through this anxiety and generously provide the reassurance that the Buyer craves and needs. Home purchases should be made from a long-term perspective. Hopefully that was the case. Has the Buyer’s housing goals been fulfilled through this purchase even though they may have paid top market dollar? Markets are not static, they go up and they go down. With time, Toronto’s market has proven that home values will increase. Probably will increase substantially. Did they buy a good house? Good houses are the quickest to go up in value. So don’t sell your Buyers a dog.
However, a problem can surface when a Buyer has a down payment that is not substantial enough. Let’s consider, for example, a down payment equal to 25% of the purchase price. If the appraised value comes in close to the Purchase Price there shouldn’t be a problem. However, if that 25% down payment equates to less than 20% of the appraised value of the property then the Buyer could be into a high-ratio situation to obtain the required mortgage so they can close the deal. Why not go for a high ratio mortgage? The Buyer’s expenses are considerably higher to carry a high-ratio mortgage. For high-ratio mortgages CMHC requires that an insurance premium be added to the principal sum of the mortgage. Full information on these fees can be obtained at the CMHC website: https://www.cmhc-schl.gc.ca
Let’s review a typical example for our tale: you sell a wonderful property to your Buyers for $1,250,000. The Buyers have $315,000 as a down payment, planning to carry a first mortgage of $935,000 for which they have been approved. With this 25% down the Buyer is not in a high ratio situation for the mortgage. Everyone is happy. Let’s now consider that in this example the appraisal unfortunately comes in One hundred thousand dollars lower, at $1,150,000. The lender will now only provide a traditional first mortgage of 80% of that appraised valuation, or $920,000. This situation now requires the Buyer to come up with $330,000 in order to close the deal without having to go the high-ratio mortgage route, making them $15,000 short.
What alternatives does the Buyer have?
HERE ARE SOME OPTIONS TO CONSIDER:
- Request that the appraiser modify their valuation.
Forget it. Don’t waste your time trying to get the appraiser to change their evaluation. For them to do that they would have to admit that they were wrong in the first place. How do you react when someone goes about trying to prove your professional opinions wrong, even when they are? Chances are remote that low valuations will be significantly improved when challenged. Choose another option.
- Request another appraisal be obtained.
The lender will usually agree to a second appraisal request. Why not?
Note: Even if the second appraisal comes in near to or at the purchase price, Lenders tend not to forget or ignore the first evaluation. Most Lenders come up with a final property valuation equal to an average between the two received appraisal prices. This may or may not do the trick for your Buyer but may well be worth a go.
- Start afresh with a new lender.
New lenders will obtain their own appraisal. So start again with another lender. If that appraisal comes at or near the purchase price the problem of a down payment short of the required 20% evaporates.
Note: The borrower may be tied into a specific bank or lender and not want to consider utilizing another lender.
Hint: Be there at or before the appraisal appointment so you and provide him/her with copies of some recent sales that substantiate the selling price. I have yet to see an appraiser ignore relevant comparable sales that are handed to them on a plate.
- Top-up the down payment.
Buyer finds another 15 grand to throw into his down payment pot to bridge the gap. Borrow the difference from the bank of mom & dad or a rich Uncle Scrooge McDuck? Use some of their saved funds planned for renovations as a down payment? The Buyers now have a full 20% of the appraised value so they can obtain a traditional first mortgage. Bob’s your uncle.
- Approach the Seller to hold a VTB mortgage for the difference.
Sellers are not always in a position to hold a mortgage but sometimes they are and may consider doing such to facilitate completion of the sale. Certainly worth investigation. VTB’s are not commonplace these days but we had a very recent situation where this described occurrence was the exact case and a VTB mortgage saved the day. In this particular situation the Buyer is obtaining the maximum possible First from the initial lender and our Realtor negotiated a VTB second with the Seller for a shorter period. The Buyer intends to close the deal and then use some of the VTB funds for renovation purposes. With renovations complete the plan is to have a new appraisal done down the road, anticipating a significantly higher valuation.
I include a couple standard VTB clauses for your consideration. These are oldies but goodies. As in fashion, give it time and everything tend to come round again.
One clause gives the Seller the right to approve the Buyer as a borrower. Please also note that when constructing a VTB second mortgage you must also put in a clause limiting the amount of the first mortgage. Not to do so would open the door for an unscrupulous Buyer to place a huge first mortgage on the property and with the VTB second that you negotiated the property could potentially be totally mortgaged for an amount well in excess of its value or purchase price. Threw that clause in as well.
SELLER TAKE BACK MORTGAGE (OPTION 1)
The seller agrees to take back on completion of this agreement, a mortgage in the amount of $XXX bearing an interest at the rate of X% per annum, calculated semi-annually, not in advance, being repayable in blended monthly payments to included both principal and interest based on a year amortization plan and to run until XXX. This mortgage shall contain a clause permitting the repayment of all or part of the principal amount outstanding on any payment date or dates without notice or bonus, provided that partial prepayment shall be in accordance with the amortization schedule for this mortgage.
SAGE15 – SELLER TAKE BACK MORTGAGE (OPTION 2), CONDITIONAL UPON CREDIT REPORT
The seller agrees to take back on completion of this agreement, a (first or second) mortgage in the amount of $ XXXbearing an interest at the rate of X% per annum, calculated semi-annually, not in advance, being repayable in blended monthly payments to included both principal and interest based on a year amortization plan and to run until XXX. This mortgage shall contain a clause permitting the repayment of all or part of the principal amount outstanding on any payment date or dates without notice or bonus, provided that partial prepayment shall be in accordance with the amortization schedule for this mortgage. The buyer agrees to provide relevant personal and financial information and is aware that a Consumer Credit Report may be obtained. This agreement is conditional until 9:00 p.m. on XXXX upon the seller’s approval of the buyer’s relevant personal and financial information and Consumer Credit Report, in his sole and unfettered discretion. If within the conditional period the seller does not waive this condition by notice delivered to the buyer or the buyer’s agent, this agreement shall become null and void and the deposit money shall be returned to the buyer in full with interest, if any, and without deduction or delay. This condition is included for the benefit of the seller and may be waived by written notice, delivered to the buyer or his/her agent, prior to the expiry of this condition.
CLAUSE TO BE INSERTED IF SELLER TAKE BACK IS A SECOND MORTGAGE
It is understood and agreed that the principal amount of the first mortgage being arranged by the buyer shall not exceed $ .
With all of this doom and gloom please realize that it is quite uncommon for appraisals to come in so far below the selling prices so as to make high ratio mortgages the only consideration for the Buyers. Most lenders consider the amount that a property sold for in an open marketplace is a reflection its true value. Frankly, we seldom see the problem I have described above. But they do surface from time to time.
Even the likelihood of these difficult situations occurring at all can be minimized further by making sure that your Buyers are not significantly overpaying for their properties, particularly if they do not have a huge down payment.
The easiest way to avoid the letdown and impact that low appraisal evaluations create, is to have Buyers avoid the possibility of getting themselves into those situations in the first place. Consult and review this possibility with your Buyers beforehand. Let’s face it; you don’t want to sell a house that can’t close. How much do the Buyers have to put down? Are they pushing themselves beyond reason to get a particular property?
Another good idea is to get any final mortgage approvals out of the way well before the closing date once you have sold a house. Encourage your Buyers to get their mortgage approval ducks in a row as soon as the transaction becomes firm. Pressures of low appraisals are far less when they surface and the Buyer is not under a tight resolution timeline.
We hope that should a low evaluation surface on a property you have sold or may sell in the future, one of these options helps you and your Buyers effectively ,resolve the matter with minimal stress.