When a VA lender evaluates a loan application, there's quite a bit of information to go over. The lender will verify your income by reviewing copies of your most recent paycheck stubs and look at two years' worth of income taxes plus your W2 forms. One of the tenets of VA loans is determining affordability so the lender will take a close look at your income compared to your monthly obligations.
Your credit will also be reviewed by the lender, both in terms of your credit score as well looking for any past collection accounts, judgments or bankruptcies. You'll also supply copies of your bank statements as well. Overall, it's a thorough process. Yet even though the lender can approve you with your credit and employment, there's another approval that must take place outside of you, the borrower: the property.
The VA Appraisal
When you make an offer on a home or apply for a refinance, the VA lender will order an appraisal after you apply for a VA loan. Most VA lenders are qualified to order appraisals on their own and place the appraisal order with an appraisal management company.
The appraisal is used to determine the current market value of the property and used to establish a maximum loan amount. Lenders will always use the lower of the appraised value or the sales price as a loan basis.
The primary method of determining value with a VA appraisal is researching recent home sales in the area and comparing them to the subject property. For example, if the home you're buying is priced at $250,000 then the appraiser will find other homes in the neighborhood of similar size and structure to see what they sold for. If your home is 2500 square feet, then the home is priced at $100 per square foot.
The appraiser will then research other “price per square foot” properties and compare them to the subject property. The appraisal should contain at least three home sales in the area that have occurred within the past 12 months, these sales are called “comps.”
If the homes in the area show that they sold for around $100 per square foot, then the appraisal will likely be at or above the $250,000 sales price of the home. For instance, one house sold for $275,000 and is 2,800 square feet, or $98 per square foot. Another home sold for $280,000 and is 2,500 square feet, or $112 per square foot. So far, so good.
However, one home sold for $250,000 and is 3,000 square feet, or $83. When the VA lender sees the appraisal and the comp is so much lower than the subject property, the lender may ask for another comp or ask for additional information about the lower-priced comparable sale. In this case, the home was vacant and in foreclosure, thus the reduced price and the lender accepted the appraisal.
No property is exactly alike. You may have three single family homes in a neighborhood that have the exact same square footage, number of bedrooms and so on but there will always be some difference, some subtle, some not so. These adjustments will add or detract from the subject property's value based upon these differences.
For example, if your property backs up to a greenbelt and has a nice canyon view and the other properties do not, there is greater value for your home based upon the view. Other adjustments can be listed such as an upgraded kitchen, a guest house or a three car garage. All adjustments are listed for each comp used.
Market Value vs. Cost Approach
Your VA lender will use the appraisal to establish a current market value, as listed on the appraisal. This is the amount that the home could sell for in an open market. There is another value listed on the appraisal called the Cost Approach. The cost approach is used by the insurance agent to help write an insurance policy and is calculated by determining how much it would cost to build the subject property from the ground up, less depreciation. That means costs for hammers, nails and permits, less any deductions for the age of the property.
In terms of getting financing, the cost approach has little value to the lender but it is something that your insurance agent likes to see before issuing a policy.
The VA appraisal is a multi-page form with literally hundreds of bits of information. Yet the most important information for you and the lender is the current market value of the property and the comps used to establish that value.