Are you being swindled?

When you apply for a loan for an investment property the bank will order a valuation on the property. Quite often the valuation the bank gets from their registered valuer will be less than the price you are paying, and in some instances many thousands of dollars below the purchase price, which may leave you wondering if you are being fleeced by the company selling you the property.

Why does this happen? There are a number of things you need to know to understand this.

What is a valuation?
An estimation of the property’s value on the real estate market.

Why does the bank have the property valued?
Because the bank has to ensure that the property is worth more than your home loan, as the property is the collateral for the loan. The lender may have to sell the property to recover the outstanding loan amount if you are unable to meet the repayments for some reason.

What is the difference between a market valuation and a bank valuation?
A market valuation will determine a property’s price on the open market, takes the property market into account and is based on a transaction done between “a willing but not anxious buyer and a willing but not anxious seller”. A bank valuation helps the lender determine their risks, will factor in selling costs if a quick sale is to be achieved and is therefore usually more conservative than a market valuation.

How is a bank valuation conducted?
There are various valuation methods, depending on the type of property being valued, the amount of the loan, the loan to value ratio, amongst others. Banks will decide which method to use. They may do a desktop valuation (obviously, from their desk), send a valuer to do a kerbside valuation (from their car while parked outside the property), or physically inspect the property (a full valuation).

A direct comparison method is used, in which the valuer will search for comparable properties that have sold in close proximity to your property, then analyse the sales, look at location, aspect, design, size, distance to amenities and services, and rates, among other things. They will also take into account their view of the direction of the property market and arrive at an estimated value. Problems with valuation will arise when you have a unique property in the area and there have been no like-for-like property sales, and the valuer has to make a best guess at the market value.

What if the valuation is too low?

If the valuation is lower than the purchase price you won’t be able to borrow the full amount you applied for and will have to make up the difference. Let’s say you are purchasing a $500,000 property. You have been pre-approved for an 80% loan to value ratio, or $400,000, thus you need to contribute $100,000 of your own money plus stamp duty and legals. The bank values the property at $480,000 and will therefore only lend you $384,000 (ie 80% of $480,000), so you now have to contribute $116,000 of your own money in addition to stamp duty and legal fees.

In most states, contracts have a “finance clause” which allows the purchaser to pull out of a transaction if they cannot obtain finance to their satisfaction. In others, there is a cooling off period which can be used in a similar way.

Bank valuations are mostly subjective, with arguable science behind them. A property purchased for $600,000 may be valued by three different lenders, who will come back with three completely different valuations of, for example, $550,000, $590,000 and $605,000. It happens time and time again, and it’s enough to make you lose your hair as you tear it out in frustration!

A good broker will help you navigate the valuation process and take the frustration away from the loan application by organising valuations before you lodge an application.

The important thing to remember is that a bank valuation is quite possibly not a fair indication of the property’s actual value or representative of the price you are paying for it, so you shouldn’t immediately jump to the conclusion that you are being overcharged. However, it is comforting to know that if the bank values your property on purchase price it probably means that it is worth more!