Changes in mortgage rules for home buyers and insurers certainly have had an impact on the housing market. These changes have impacted property appraisals as well. Conventional mortgages – up to 80% of the value of the property – historically, were required to have a full appraisal. Now, in many areas of the country, an appraisal may also be required on insured mortgages – 80 to 95% loan-to value.

The decision to approve a conventional mortgage, after all other lending criteria have been satisfied, is made on a property’s fair market value. This is defined as: the market value of an interest in land at the highest price reasonably expected, when sold by a willing seller to a willing buyer, after an adequate amount of time and exposure to the market.

So who determines the value of that property? One could argue that the market itself determines the value. This is true, but from a lender’s perspective that number must come from an independent third-party – the appraiser. An appraiser is specifically trained and has sufficient experience to offer an impartial, written opinion of the property’s value.

Realtors normally use a comparative market analysis (CMA) to evaluate a property’s value based on local market data. Agents analyze listing and sales data for comparable properties in the area to recommend a price to list or to offer. However, a CMA is not an appraisal. Although appraisers use the CMA approach, they use it in combination with other factors to determine the value of a property.

The major difference is that appraisals are done for a specific client – the lender. Because real estate is the major security for mortgages, the market value estimate needs to be as accurate as possible. Appraisers use ‘sold’ properties information only and compare similar property types, in close proximity. These properties must have sold within a relatively short period of time – usually 90 days.

Not all residential properties are subject to a traditional appraisal. If the property is in an established area, with similar properties, then sometimes the price can be validated electronically. This model of appraising property, called automated valuation model (AVM), has become quite popular in the last 10 years.

However, given the nature of the housing market these days, mortgage lenders have moved away from AVMs. For conventional mortgages, and for some high-ratio mortgages as well, they are asking for live, full on-site appraisals.

At the end of the day, an appraisal must reflect a property’s realistic true market value. It also needs to be backed up with accurate data.

So why does an appraisal come in lower than expected?

With the introduction of bidding wars, where, in some areas, prices may be artificially inflated, appraisers are still tasked with coming up with a property’s fair market value. Rapidly changing markets can be very challenging for an appraiser to properly evaluate a home’s worth.

Appraisers will try to get to the purchase price when evaluating a property. However, sometimes the sale is a few weeks ahead of the market. If prices are increasing, it may not show up in their analysis yet and the appraisal will reflect a lower value.

At the end of the day, the appraisal has to be a realistic evaluation of a property’s true market value and be backed up with data.