When you contact a real estate agent to sell your home, part of their job is to tell you what your house will likely sell for. They don’t pull that number out of thin air – they tap into comparable sales, sometimes known as “comps” for short, to determine a reasonable value for your home. In this post we’ll look at how comparables work, and how they can impact your financing.
What Are Comparable Real Estate Sales?
For more than a decade now, multiple offer “bidding wars” have been the norm in the Toronto real estate market. One of the downsides to this has been that after “losing” in previous bidding wars, some buyers throw caution to the wind and offer significantly higher than the asking price to ensure their offer “wins.” But paying more than a house is really worth can have bigger ramifications than just buyers’ remorse.
Related Read: How to Win an Emotional Bidding War
Before issuing a mortgage, your financing company will want to determine your loan-to-value ratio, and your ability to carry your mortgage. A particularly high home sale price might raise some warning flags at the bank during this step, leading them to call in an appraiser to determine the true value of a home. The bank wants to ensure they’re not paying for a home that’s overvalued and that could risk depreciation.
For example, let’s say that in the frenzy to get that lovely two-bedroom Toronto townhouse that’s close to work, you ended up paying $600,000 for it. Before finalizing the mortgage, the lender calls in an appraiser who looks at the sale price of other two-bedroom townhouses in the area that sold recently and calculates the property is only worth $520,000.
If you didn’t include any conditions on financing with your offer, you’ll need to somehow figure out a way to come up with that $80,000 difference – along with your down payment – or withdraw your offer, meaning you’ll likely lose your deposit and face some hefty legal headaches.
For sellers in a cooling market – such as we seem to be in now – the price your agent gave back at the beginning of the sales process may not accurately reflect current market conditions by the time you get to offer night. That could lead to you have higher than realistic expectation or, worse, spend more on your new home than you can afford from the proceeds of the sale of your current one.
Apples and Oranges
While banks will only use reputable appraisers (certified by the Appraisal Institute of Canada), there can be some grey areas when determining comparables.
When appraising that townhouse, for example, an appraiser will ideally find truly comparable units within your complex. But if nothing’s sold in the area recently, they’ll have to go further afield to find comparables.
But anyone who’s been in the market for a house knows that one two-bedroom townhouse with parking is not the same as all the others. Some condos, for example, have extensive amenities such as gyms, basketball courts, and pools. With others, the shared amenities may amount to little more than the laneway leading to the parking spaces.
But by focusing on a few key parameters (square footage, number of bedrooms and bathrooms, parking spot or not) the appraisal can skew the value they give your home up or down significantly.
Comparables When Refinancing
Even if you have no plans to move, comparables can impact your finances. Say you’ve decided to refinance your home in order to take out some of its built up equity so that you can undertake the renovations you’ve always wanted.
In most cases, part of the refinancing process will involve having a professional appraisal. If you were hoping to tap into a significant amount of equity for your renovations, now might not be the best time to refinance.