Appraisal and Property Requirements for a Mortgage

When qualifying for a mortgage, you need to understand two words: appraisals and property requirements. What is an appraisal report? Property requirements?

Mortgages carry much lower interest rates than other loans, like personal loans, car notes, etc. Cars, though they are valuable items, depreciate considerably over time, which classifies them as liabilities.

When a borrower defaults on a liability, lenders nearly always take a considerable loss even after successfully repossessing the item.  

In the mortgage industry, a lender’s collateral is the property that they lend against. Since developed real estate is a strong asset shown on average to appreciate over time, and since securing loans with strong assets greatly decreases a lender’s risk exposure, lenders are able to offer much cheaper interest rates on residential mortgages. Still, there are always ranging levels of risk within asset classes.

When it comes to property, a lender’s risk is assessed by type, value, and condition.

Quick Look at Mortgage Appraisals and Property Requirements:

• Property Type
• Property Value
• Property Condition

Property Type

When looking at appraisals and property requirements, the property type is important. There are several different property types, each with its own qualifying mortgage criteria. The following are the most common examples ranked from least to most risky in the eyes of a lender and are therefore easier or harder to finance using a residential mortgage loan.

1. Single-Family Home

A single-family home is a stick-built home, assembled from scratch on-site. Owners own the land as well as the structure on top. This is the most common type of residential property, and the easiest to finance.

2. Duplex

Duplexes are the same as single-family homes, the only difference is there are two livable units rather than one, adding an additional layer of risk.

3. Multi-Family Home/ 3-4 Unit Property

This is the same concept as those above, only with 3-4 units, still easy to finance though they require slightly stricter guidelines.

4. Townhouse/ Rowhome

A townhouse is most similar to a single-family home in ownership terms; however, the structure is physically connected to other properties in a row, which means that there may be a homeowners association in the mix, as well as additional insurance requirements.

5. Modular Home

Modular Homes are homes largely assembled in a factory or offsite and transported to the property in 3 or more pieces. Any less and the property is considered “manufactured.”

6. Condominium

This is where things get a little dicey. Condominiums are a type of collective where owners technically own a unit and everything “walls in,” meaning that any exterior walls, land, and common areas are owned and maintained by a homeowners association. The fact that associations play such a pivotal role in condos means they add a considerably higher risk factor for lenders.

For FHA and VA loans, condos are virtually unfinanceable. There is such a laundry list of qualifying criteria it is rarely worth trying. However, if you have the credit score to qualify for a conventional loan, the guidelines are much less stringent.

7. Manufactured Home/ Mobile Home

Manufactured and mobile homes are homes built almost entirely offsite and are shipped in either whole or in two pieces. After construction, they are still usually able to be moved from one lot to another. Even if they are permanently affixed or added onto, however, if a home begins as a mobile/ manufactured it will forever be considered mobile/ manufactured by lenders.

This is crucial because this property designation will exclude borrowers from financing with traditional mortgage products.

8. Cooperative Unit

Coops are almost the same as condominiums in terms of the living situation; however, in terms of ownership, they are very different. While a condo owner owns real property (the inside of their unit), coop owners technically own no property. Rather, they own shares in a corporation which in turn gives them rights to a unit.

The difference is subtle in practice but legally this distinction makes a huge difference. Not only does it give the association much more power over rules and decision-making and transfer of property, but also means that there is technically no property for lenders to foreclose on in the case of default. As such borrowers must usually finance coops with a share loan rather than with a residential mortgage (There are exceptions in the state of New York).

9. Vacant Land

Vacant land is exactly as it sounds. Being that it is undeveloped and therefore unlivable. Other forms of financing, like business or personal loans, or loans specifically designed for vacant land, must be sought for purchase.

10. Commercial Property/ 4+ Unit Property

Commercial property is not financeable using a residential mortgage primarily since it is not residential property (duh), but also because it is considerably harder to assess property value and loan risk on commercial properties.

Property Value

The property's value is another aspect of the appraisals and property requirements. Lenders must also verify the value of a property to ensure that the collateral is valuable enough to cover their risk exposure. A significant portion of a lender's risk exposure is determined by the size of the loan compared to the size of the borrower’s downpayment.

In other words, the loan-to-value ratio (LTV). This means that if you, the borrower, place a 20% down payment at closing, your lender will calculate the LTV at 80%. Since your down payment is, in turn, your equity, larger your down payment, the more you have to lose as a borrower, and the less risky the loan is for your lender.

This 80% threshold happens to be a major benchmark on Conventional Loans. Lenders have found, through much trial and error, that after a borrower exceeds 20% down they are much less likely to cut their losses and default. Therefore by making this investment, you are no longer required to carry private mortgage insurance (PMI), a considerable expense that often costs hundreds of dollars monthly and offers no direct benefit to you as a borrower.

Appraisals

Lender’s figure property value and the subsequent LTV by getting the property appraised during the mortgage loan process. Licensed appraisers cite comparable, recently sold, homes in the subject property's vicinity (comps). They, then, factor in the property's square footage and specific features to determine their valuation based on the current market value of the home.

Since no lender would write a mortgage based on an inflated valuation, and since you and the seller would have already agreed on a purchase price at this point, if the appraisal report returns with a lower-than-expected valuation it can create a tenuous situation where parties may have to renegotiate or back out of the deal.

So, how much does a home appraisal cost? That all depends on the appraiser you hire. You will find different prices offered by different appraisers during the home appraisal process.

And how long does an appraisal take? Depending on the lender, property appraisals could be scheduled within days or even weeks. Now, on to the next question, What happens after an appraisal?

Property Condition

Although the primary purpose of the appraisal is to determine the value of the property, appraisers must also determine whether its condition meets the requirements set by Fannie Mae, Freddie Mac, or government guidelines. Generally speaking, government-backed mortgages (FHA, VA, USDA.) are strict on property condition, deeming properties ineligible for things as small as a missing handrail or cracks in the sidewalk. However, conventional loans (Fannie/ Freddy) are much more lenient in this respect, concerned mostly with the structural integrity of the property, and whether the property is under construction or unfinished in any way.

Red flags for Conventional Loans:

• Unfinished construction
• Major damage to sheetrock and drywall
• Outdated or faulty heat/ AC
• Utilities turned off
• Outbuildings in poor condition
• Roof or siding in poor condition

Red flags for Government Loans:

• All of the red flags listed for conventional loans
• Chipped or peeling paint
• Missing handrails
• Major cracks in driveway/ sidewalk
• Holes in drywall
• Leaky basement
• Visible subfloor

After an appraisal is completed, if the subject property has any of these defects it is not an immediate deal-breaker. For those looking to refinance, it is fully within your control to bring the property up to snuff and get it reappraised before your rate lock expires. For those seeking to purchase, however, things can be a little more difficult.

Usually, sellers are incentivized to make the necessary changes in order to salvage the deal; however, less motivated sellers may occasionally be unwilling to make upgrades unless buyers contribute to, or cover, the cost.

Final Note About Appraisals and Property Requirements

Sometimes what looks like a perfectly normal home ends up being a manufactured home in disguise; other times appraisers cite incomparable “comparables,” leading to poor valuations. In the end, property classifications and appraisals are imperfect but remember we’ve lived the alternative to these strict guidelines, and, in 2008, we saw its consequences. The best thing to do in the current system is to learn what to look out for and try your best to avoid wasting time and money.

Now that you better understand how to get a mortgage and the specifics of a mortgage down payment, are you ready to take the leap into homeownership?

Frequently Asked Questions