When you are going through the land/home purchasing process it can be quite a tall task. There are many things to do and many items you need to keep on your mind. One of these things is the Appraisal. For those of you who have purchased a home or land before, you may be familiar with it and understand why you need one. For those who are new to buying property, I want to share with you what we have learned while on our journey.
First and foremost, I am not a real estate agent or loan officer, so I speak only from personal experience. We have purchased a home in the past, but we have never purchased raw land. You would think that it would be the same as buying an existing home, but it is not. What makes it different is the fact that lenders view land as a higher risk. Most banks will charge higher interest rates, offer shorter term loans (15-20 years as opposed to 30 years), and/or require larger down payments on raw land. In addition, you are limited by the acreage that they are willing to finance. You see, banks start to get a little antsy with anything over 5 acres and they really start to hit the brakes with land over 10 acres! Again, it boils down to risk. If you have a structure on a property, it is viewed as an asset where their cost can be recouped. If you have land and for some reason they have to recoup their cost, all they have is just….well, land. The value isn’t as much as one with a building on it and depending on the condition, location, etc. of the land it may be hard to resell. This does not mean there are no lenders out there who will finance large properties. They are out there, you just have to search.
Once you find a lender to finance your land purchase, both you and them must know that the property is of some value. The way to do this is to have an appraisal ordered (by the way, you will have to pay for that appraisal, whether it be out of pocket or at the closing of your property acquisition). The appraisal tells you and the bank how much your land is worth today at fair market value, based on factors including but not limited to:
- Location
- Comps (properties in the same area that compare to yours in size and how much they are worth)
- Is it wooded?
- Is it cleared?
- Is it buildable?
Those types of things go into the calculation of your appraisal and the hope is that the land is worth more than what you pay for it. At a minimum, you want the land to appraise for the purchase price, but let’s look at an example.
You wish to purchase a 7 acre lot for $50,000. When you make an offer for the land, you hope to get it less than the list price via negotiations, but that may not always be the case. Sellers may hold firm at their price depending whether or not the market favors them. Let’s say you are able to get an offer accepted for $47,000. SCORE for you!!! You were able to get $3,000 off the asking price! Now, once you get to the point in the process when you are ready for the appraisal, you want the property to be worth at least $47,000.
Scenario #1: The appraisal comes back and the property is worth more than the accepted offer price of $47,000. This is the ideal scenario as this means you will have equity in the land. Simply, equity is the market value of your property minus the amount you have left on your loan.
Scenario #2: The appraisal comes back and the property is worth the same amount as the accepted offer. Well, you don’t have equity, but the value of the property isn’t less than your offer. It’s not ideal, but at least you are not upside down (paying more than it’s worth) in the property.
Scenario #3: The appraisal comes back and the property is only worth $45,000. Well that sucks, but you have some options. You could: a) ask the seller to reduce the offer to match the appraisal value; b) if the sellers are not willing to reduce the price, you can still buy the property, but you’ll have to pony up $2,000 to make up the difference ($47,000 offer price – $45,000 appraisal); c) You can simply walk away.
At this point, if you thought you had found the perfect property, option “C” in scenario #3 may be hard. However, I would encourage you to not be afraid to walk way. Like Deidra stated in our last journey update, we thought we had found the perfect property only to find out it wasn’t. It was difficult and gut-wrenching to do, but we simply had to walk away. For us, it was better to walk away with nothing than to force an issue that would cost money and gives us nothing but problems.
It matters that your property has value and is expected to increase in value. Ideally, you will want your appraisal completed during your Due Diligence period, so you can have an opportunity to back out of your offer (and recoup your Due Diligence fee) if things do not work out mathematically. Again, I am not a realtor or loan officer, however, I have talked to quite a few of them over the past year and some change. It has been frustrating at times and rewarding as well due to the wealth of knowledge that we have gained during the process. Overall though, I wouldn’t have it any other way. After all, if we had not been through what we’ve been through, then we wouldn’t be able to share our experiences with you.
Take care and more as the journey continues!