When you apply for a home loan, the bank will value the property to determine the market value, right? Wrong! While it’s true that when you apply for a mortgage, your bank will place a value on the property you’re buying, the figure they come up with is not necessarily an accurate representation of the property’s value.
“Banks are willing to become business partners with property investors, so that you both can achieve something you couldn’t do without the other, but their support is not unconditional,” explains Bernard Kelly from www.retirelaughing.com. “Novice property investors often expect a bank valuation to mirror the market price. In fact, a bank valuation is only an internal control tool, which reflects what a bank can reasonably expect to recoup should it need to repossess and sell the property in distressed circumstances. This is why it’s less than market price.”
Generally, banks will value the property at the lower end of the scale as they need to protect their risk. If you stop making your repayments and they’re forced to sell the property to recover the money they’ve lent you, they want to be satisfied that they’ll be able to cover the debt. They need to factor in extra expenses like real estate commission, legal fees and timeliness, so it pays for them to be cautious in their estimate. Occasionally, banks may also apply conservative bank valuations if they change their internal policy, and decide they want to “move away from the total amount that they lend for housing”, Kelly confirms. “It happens from time to time.”
You only need to cast your mind back a few years, when we were in the grips of the GFC, to remember that lending criteria changed virtually by the day as banks scrambled to keep quality loans on their books. While banks may veer towards conservative values, the valuation put on a property by an insurance company is often above the market value, Kelly adds. “For insurance purposes, a valuation simply reflects what the insurance company would reasonably expect to pay out should the property need replacing – for example, if it was to be destroyed by lightning in say two years’ time,” he says. In this instance they need to factor in a little “cushion” to cope with inflation/CPI and rising costs of construction. “As you can see, valuations are tools the big corporates use for their own purposes,” Kelly says. “You should always keep in mind that they only loosely relate to the real market price.”