Does the reason for the loan determine the home’s value?

Does the reason for the loan determine the home’s value?

I was speaking at a local real estate office recently and was asked an interesting question. I thought I would share it with you along with my answer because I’m sure others may have wondered the same thing. The agent asked “does the reason for the loan determine the home’s value?” Lets take a look at what needs to be considered when answering this question.

What value?

There are various types of value that an appraiser can provide, such as market value, value in use, investment value, insurable value, and liquidation value. The majority of time the value a bank will be asking for in an equity loan, home purchase, or refinance, is market value. Market value is defined as:

Market value is the most probable price that a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

• buyer and seller are typically motivated;
• both parties are well informed or well advised, and each acting in what he or she considers his/her own best interest;
• a reasonable time is allowed for exposure in the open market;
• payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
• the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

The bottom line is that the bank or lender wants to know what they could sell the home for if they had to take it back in foreclosure. The other types of value I mentioned besides market value are for special situations and aren’t important to our discussion here, but I thought I would mention them to let you know that they exist. Market value will be our focus here when discussing whether the value will change when the reason for the loan changes.

Types of Loans

The different types of loans that most people would get include a home equity loan, purchase loan, or a refinance loan.

Home equity loan- A home equity loan allows a homeowner to use the equity they have built up in their home to borrow money from the bank for various reasons including home improvements, pay for college, or to purchase something.

Home purchase loan- A purchase loan, as the name implies, is used to buy a home using the bank’s money. You then make payments to the bank every month.

Refinance- A refinance loan allows the homeowner to get a better interest rate and term on their loan. It doesn’t give them any money but can allow them to have lower house payments and pay the loan off sooner.

When lending money in the above situations the bank or mortgage company is concerned with what the market value of the property is in case they have to foreclose on the home.

Does the reason determine the value?

So far we’ve looked at what type of value the bank is interested in the appraiser providing and the three types of loans that homeowners typically get. Banks or mortgage companies hire real estate appraisers to determine the market value for each of these types of loans so technically speaking the values should all be the same and the reason for the loan does not determine its value.

Sometimes different appraisers can come up with different values but they should be relatively close if they are using the same comparables. Appraiser education and experience will also play a role as those with more experience and knowledge in an area will usually provide a more accurate appraisal. The varying education and experience levels of two different appraisers should not be used to explain differences in appraisal value just because there is a difference in the type of loan obtained. What we are looking at here is whether the type of loan the borrower is getting influences the appraisal value, which it does not.

One thing I would like to mention is that with a purchase appraisal there is one additional piece of information that the appraiser has that the other two appraisals do not and that is a contract for the purchase. A sales contract is another value indicator, along with the sales comparison, cost, and income approach,  that can be relied upon to come up with an opinion of value. So, while the reason for the loan didn’t help determine the value, another piece of information that was not available for the other two types of appraisals did. Market value is market value and given the same sale comparables and time period the market value for each of the loan reasons should be similar.

Question

Do you have any additional questions or comments about this common question? If so, leave your comment below and as always thanks for reading and contributing.

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