“My realtor says the property is worth XXX, why doesn’t the lender see it that way?”

Mortgage brokers are on the front lines of this conversation on a weekly basis. We’re constantly involved in situations in which a buyer has committed to a property at a price that is significantly higher than what it was listed for -- with comparable sales that do not support the price the buyer agreed to pay.

In these situations, lenders generally refuse to lend. This leads to anxious and increasingly desperate buyers scrambling to find financing. It’s this ‘desperation deposit’ that’s helping to drive record home prices in the market right now.

READ: What’s the Biggest Mistake People Make When Securing a Mortgage?

Here’s a recent example we had to deal with at The Mortgage Trail:

Our clients agreed to purchase an East York property that was listed for $999k for just over $1.5M. The lender’s subsequent appraisal of the home's value did not support that purchase price, which set a record for its street.

In other words, the street value (forgive the pun) doesn’t always reflect the appraised value, which can lead to trouble for new buyers…

Lenders Rely on Appraised Value not Market Value

Lenders rely upon the professional valuation of a certified Appraiser who researches the market to determine a reasonable valuation. How do they land on that value? In part, through comparable sales. They investigate recent transactions on similar properties and compare it to the subject property to determine a value.

An appraiser is an arm’s length, certified professional, specifically trained to value the property. They don’t have a vested interest in the transaction. The client’s realtor, however, has a very vested interest in the transaction, and the buyer wants to buy, so this is what leads to seeing bids that are well over the list price.

Unconditional Offers

Unconditional offers can leave prospective buyers obligated to buy a home that lenders will not finance. 

Compounding the problem is the lack of house inventory available for sale. After bidding and losing repeatedly, buyers can feel an increasing sense of panic or urgency. This kind of FOMO in a sellers’ market results in overbidding.  

When inventory is more balanced, buyers can make offers with conditions (home inspection, financing, etc.). In today’s environment, offers with conditions are simply not considered, often resulting in the unconditional offers leaving prospective buyers in need of financing that lenders simply will not support. 

Who’s Lending Who?

If sales are setting records, lenders must be lending extra money, right?

No, they aren't.

Lenders provide mortgage financing based on either the selling price or the appraised value, whichever is lower. A lender is taking a risk on every property they finance, the realtor isn’t -- it’s the lender who must be careful not to overpay. There is wiggle room, of course, and mortgage brokers help to bridge lenders and clients, but only to a certain extent.

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Sales records are being set because buyers are overpaying and then finding extra financing that makes up the difference. This financing reduces the lender's risk as well as the overall mortgage amount. Usually, this helps them agree to finance the purchase, but it can go down to the wire. 

Where is the buyer’s extra money coming from? Often from generational wealth.          

Buyers Turn to the Bank of Mom and Dad

We have over 100 clients in various stages of home buying (investigating options, placing offers, etc.) and, increasingly, it’s parents who are helping a purchase jump through financing hurdles, either by contributing large down payments or by joining deals as guarantors and leveraging the equity that their own homes have gained over the last few meteoric decades of home price gains.

READ: 40% of Young Ontario Homeowners Received Financial Help from their Parents

Back to our East York buyers. The lender’s valuation meant that they needed to come up with an extra $100,000+ that they had not budgeted for. Lucky for them, their parents were in a position that they could help. But buyers without a safety net could find themselves out of a deposit or even taken to court.

Lenders Are (Mostly) Not Lending More

Lenders are not being reckless amid all these record prices and bidding wars. Rather, buyers are simply making up the difference and setting new price precedents in the process. These bully offers find extra financing, which set comparables that bring the appraised value of nearby homes up. The market keeps floating up and up. To borrow a phrase that seems particularly appropriate for the current market: “A rising tide lifts all boats.” 

If you’re concerned about overbidding or thinking about leveraging wealth that is available to you, talk with a mortgage broker to make sure understand the risks you’re accepting and -- in an ideal world -- what options exist if the property valuation comes in below what you’re hoping for.

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