Marcus Marion, CMA™ In a previous article, we explored the basic steps to buying a home with a VA loan. One of those steps involved the lender ordering a home appraisal, to determine the market value of the property being purchased.
In this article, we will cover two of the primary reasons why VA loans require a home appraisal, and how these requirements can affect the buyer.
Home Appraisals Are Required for VA Loans
The VA loan program is managed by the U.S. Department of Veterans Affairs. This unique program allows military members and veterans to buy a house with no money down whatsoever. Eligible borrowers can also avoid paying mortgage insurance, which is typically required with a low down payment.
While they offer significant benefits over other mortgage options, VA loans also have specific requirements for the borrower and the property being purchased. One of those requirements is that the home must be appraised prior to closing.
A home appraisal is an unbiased professional opinion of a home’s fair market value. It is typically required by mortgage lenders to ensure that the loan amount is not more than the property’s value. Appraisals are also commonly used in refinance transactions, estate planning, and other purposes.
In the context of VA loans, the appraisal process primarily benefits the lender. But the home buyer can also benefit from the property being appraised. In some cases, this process can prevent a buyer from unwittingly paying more for a home than it’s currently worth.
The VA Home Loan Guaranty Buyers Guide, published by the Department of Veterans Affairs, explains it this way:
“The appraisal provides an appraiser’s opinion of value of the home and whether it meets VA’s minimum property requirements. It also assures you and your lender that the value of the property is based on facts and market data, not just the seller’s opinion. It can help give you confidence that the home you want to purchase is worth the investment you are making.”
Two Reasons for the Appraisal
As mentioned in the above quote, there are two primary reasons or requirements for the VA loan home appraisal.
1. Determining value.
The appraiser will compare the home being purchased to recent sales in the area, in order to determine the current market value. The appraiser might also visit the home in person, to help with this valuation.
This process is important for all parties involved, especially the mortgage lender and home buyer. The goal here is to ensure that the buyer is not paying more for the property than it’s currently worth.
In this way, the VA home appraisal is similar to those used for conventional (or non-government-backed) mortgage loans. Regardless of the type of loan being used, the lender wants to know how much the house is worth prior to funding the purchase.
2. Minimum property requirements.
With a VA home appraisal, the appraiser has a secondary role and responsibility. He or she will also review the property being purchased to make sure it meets the minimum requirements set forth by the Department of Veterans Affairs.
We’ve covered these minimum property requirements in a previous blog post. The short version is that the home being purchased must be safe and habitable for the new occupant. It must be livable and move-in ready, without the need for extensive repairs.
Those are the two minimum requirements for a VA loan appraisal, and it’s partly what makes this program different from conventional mortgage financing.
- With a conventional home loan, the appraisal will mainly focus on determining the current market value of the house.
- The VA home appraisal, on the other hand, has a “dual-purpose” mission to determine the market value as well as the overall condition of the property.
VA loans differ from conventional financing in other ways as well, including the zero down payment option. It’s one of the only mortgage programs available that allows a person to buy a home with no money down and no mortgage insurance.
Understanding the ‘Escape Clause’
When you use a VA loan to buy a house, your purchase contract will likely include something known as the “escape clause.” Basically, this clause allows you to back out of the deal without losing your earnest money, if the appraisal comes in lower than the purchase price.
In other words, if the appraiser determines that the house is worth less than the amount the seller is charging, you can exit the deal without forfeiting your deposit.
With a conventional mortgage loan, this kind of “appraisal contingency” is optional. It’s up to the home buyer whether or not they want to include it in their contract. Sometimes, a buyer might waive or omit the appraisal contingency to make their offer more attractive to the seller.
But with a VA loan, the home appraisal escape clause must be included within the contract.
This important clause states that the buyer “shall not incur any penalty by forfeiture of earnest money or otherwise be obligated to complete the purchase of the property described herein, if the contract purchase price or cost exceeds the reasonable value of the property established by the Department of Veterans Affairs.”
The escape clause goes on to explain that the buyer can choose to proceed with the purchase of the home, despite the low appraisal situation. If the buyer really wants the house, and the seller refuses to lower the price to match the appraisal, the buyer could pay the difference in cash at closing.
But the escape clause gives the buyer a choice in the matter, by allowing them to cancel the deal if the appraisal comes in below the purchase price.
