The real estate market so far this year has been unexpectedly frenetic with some properties selling for significantly more than their market value. The Globe and Mail reported this phenomenon as “sticker shock.”  One of the consequences of properties selling for over value (value is different from listing price) is that these properties likely won’t appraise with the bank and that can have disastrous consequences for the buyer. If you’re a buyer in this market, here’s what you need to know about mortgage appraisals.

First, a necessary disclaimer. We are not mortgage brokers. For a more indepth discussion of appraisals and financing in general, please speak with your mortgage broker or bank.

Now, what is the difference between mortgage pre-approvals and mortgage appraisals? When you get a mortgage pre-approval, the bank is giving you a maximum budget based on your down payment, income and debt. An appraisal is when the bank determines the value of a property. In other words, even if you have been pre-approved for a certain amount, the lender will only loan you money based on their analysis of the value of the home you have purchased. Making sure the bank will finance the purchase based on the purchase price is main reason for including a financing condition.  However, it is difficult to win in a bidding war with a conditional offer. Historically, if you had a pre-approval and determined the value of a property by using recently sold comparable properties you could be safe to make an offer firm on financing.

However, 2017 has been a wild ride for this market with several homes selling for way over value. This trend means there are several sales taking place around the city that won’t appraise with the bank.

What are the implications? If you are a buyer relying on financing and you offer over value you will have to come up with more money to account for the discrepancy between your offer price and the mortgage appraisal value.

For example:

You have been pre-approved for $1,000,000 and offered all $1,000,000 on a home but the bank appraises it at $800,000. You have been pre-approved for a mortgage based on a 20% downpayment. This means that you presumably already have $200,000 in the bank. However, the bank is only going to loan you 80% of the $800,000, which is $640,000. You then have to come up with an extra $160,000 for a total downpayment of $360,000.

What is a buyer supposed to do?

1. Know your limit and stick to it. Don’t get carried away in a bidding war. Even if you have been pre-approved for more money, follow your agent’s advice on the actual value of the home.

2. Ask your agent to give you two values. The first is the home value based on market comparables. The second is the price that the house could reach based on all the frenzied activity.

3. Use cash. This is obviously not possible for everyone. But, where possible, get a nice cushion just in case the property doesn’t appraise out and you have to come up with the difference.