Real estate investors rely on numbers to make decisions. Before buying a property, you estimate its value, calculate your expected returns, and determine how much financing you’ll need. When refinancing, you may estimate how much equity you can access.
But what happens when those assumptions don’t hold up? The value you estimate may differ from the lender’s appraisal, or the credit score you monitor may differ from the one used to evaluate your loan application.
These differences can affect how much you can borrow, your interest rate, or the cash you need to bring to closing. They don’t necessarily mean a deal is dead, but understanding where these discrepancies can arise can help you set realistic expectations and prepare for your next financing decision.
Property Value: What If the Appraisal Comes In Differently?
When financing a property, you’ll likely provide an estimated value based on the purchase price, comparable sales, or your understanding of the local market. The lender, however, will generally rely on an appraisal to establish the property’s value for lending purposes.
If the appraised value differs from your estimate, it can affect your financing in several ways.
If the appraisal comes in lower than expected, you may have less borrowing power than anticipated.
For example, suppose you’re refinancing a rental property you estimate is worth $210,000. At 75% loan-to-value (LTV), you could expect a loan of $157,500.
If the appraisal comes in at $200,000 instead, a loan at 75% LTV would be $150,000. That’s $7,500 less than you expected to receive from the refinance.
A lower appraisal can also create challenges when purchasing a property. Depending on the loan program, the lender may base its maximum loan amount on the lower of the purchase price or appraised value. If the appraisal comes in below the agreed-upon purchase price, you may need to renegotiate with the seller or bring additional cash to cover the difference.
If the appraisal comes in higher than expected, you may have more flexibility.
On a refinance, a higher appraised value could allow you to access more equity, subject to the lender’s maximum LTV and other requirements. Alternatively, if you only need the amount you originally planned to borrow, the higher value could lower your LTV. Depending on the lender’s pricing, that may help you qualify for a better interest rate.
The best option depends on your investment goals. More cash isn’t always the priority; sometimes, keeping borrowing costs down makes more sense.
Investor tip: Research comparable sales before applying for financing to develop a realistic estimate of your property’s value. While you can’t guarantee what an appraiser will determine, using relevant market data can help you avoid building your financing plans around an unrealistic valuation.
Credit Score: Is the Number You’re Seeing the Right One?
Your credit score is another number that may not be what you expect when applying for a loan. You might regularly monitor your score through your bank, credit card company, or a service such as Credit Karma or CreditWise. But the score you see isn’t necessarily the one your lender will use.
That’s because different services can use different credit scoring models. Mortgage lenders may use mortgage-specific FICO models and obtain credit information from multiple bureaus. The score you see through a consumer-facing service may therefore differ from the score used to evaluate your loan application.
Here’s a real-world example. While refinancing rental properties in our portfolio, I checked the FICO Score 9 provided by Wells Fargo and saw a score of 832. When my credit was pulled for the refinance the previous week, the score came in at 778.
That’s a 54-point difference. My credit hadn’t suddenly deteriorated by 54 points; the scores were based on different scoring models and potentially different underlying information.
Why does this matter? Your credit score can influence the financing available to you.
If your lender-used score is lower than expected, you could face a higher interest rate or a lower maximum LTV, depending on the lender and loan program. Your financing options could also be limited if the difference affects your eligibility.
If your lender-used score is higher than expected, you may qualify for more favorable terms. The actual benefit depends on the lender’s pricing structure and the other details of your loan.
Investor tip: If you plan to finance a property in the near future, consider reviewing your credit reports, correcting any errors, and taking steps to strengthen your credit before applying. These steps won’t guarantee a particular score, but they can help you put yourself in a better position.
Plan for the Numbers to Change
When evaluating an investment property, it’s important to understand which numbers are estimates and which have been confirmed. A property’s value and your credit score may seem straightforward, but both can differ from the figures used to determine your financing.
Before committing to a deal or planning a refinance, use market data to develop realistic expectations, understand how your credit is evaluated, and leave some flexibility in your financing plans.
You can’t control every variable in the lending process. But by identifying the numbers that could change and understanding their potential impact, you can make better-informed decisions and reduce the chance of an unexpected financing hurdle derailing your plans.
Thanks for reading this week’s Experience, and best of luck in your real estate investing journey!
-BROCK