Arranging for a property valuation prior to purchase, or a valuation on a property you already own for refinance, is relatively straightforward. That said, it’s important to understand potential pitfalls associated with a valuation so you can brace for a possibly unfavourable outcome.
If you are applying for a loan from a bank, they will normally commission a valuation and rely on its findings when deciding whether to lend the amount requested.
What you may not know is that the valuer reports provide the bank with much more than just a figure. Certain elements within the report other than the valuation number can affect the outcome of your application.
Valuation vs. appraisal
Before we dig in, let’s get this fundamental straight.
A valuation is different to an appraisal.
An appraisal is an assessment done by a selling agent to give an indication of what the property could sell for on the open market. It’s usually based on only a few variables – the main one is recent comparable sales in the area, followed by the condition of the property, and then the number of buyers making active enquiries for similar properties, and finally, the agent’s expertise.
A valuation done by a qualified valuer (who has completed a university degree) incorporates a vast array of variables and can result in a different figure than the appraisal (it almost always is a lower figure than the appraisal).
A valuation is based on things like the land value, improvements done to the property, town planning considerations, an analysis of the property’s layout (living areas vs bedrooms vs outdoor areas and car spaces). But it also contains a number of other professional observations about your property’s suitability as security for a loan.
A Valuer’s role is to ascertain your property’s “Fair Market Value”. It’s important to understand this as it’s one of the most common things that people query. It’s what it “could” sell for but more likely based on market at the time, what it “would” sell for in the case that the bank had to realise the asset.
A big part of the valuation process includes a risk ratings, which the bank relies on as part of its decision-making process. Even if you get a good valuation figure, you may still not be approved for the loan if the risk rating is too high for the bank’s appetite.
Simply put, risk ratings are how the bank determines the level of risk attached to lending against a particular property.
Risk ratings are ranked from 1 (low) through to 5 (high risk). Depending on how risk averse your lender is, a rating of 4 or 5 is unlikely to result in a green light on your loan application.
Risk ratings are based on factors that include:
- Location: If the property is situated on a busy road, or beside a noisy facility (eg a train station, or industrial factory that makes noise) this is going to result in a higher risk rating. It doesn’t matter how stunning the property is, a poor location will negatively impact the risk rating it receives.
- Land: What size is the block and how much additional space around the house is there? How is its topography or drainage a challenge. Is it useable and appealing as a site? These will affect risk ratings.
- Environmental issues: Is the property in a bushfire risk zone, or are there flood risks, in some areas powerlines could be an issue, or telephone towers – these all impact the valuation and its risk rating.
- Improvements: Has the property been well maintained? Are there renovations that have added value? Is it falling apart? If so, this could indicate that the property may also have underlying issues that similarly haven’t been taken care of and this could be a red flag for lenders.
- Expected reduced value in the next 2-3 years: Lenders always want to know which way the wind is blowing when it comes to the market and if the property might fall in value in the next few years. This would need to be factored into the lending decision and how much to lend.
- Market for the area: What is the economy doing locally? How is the market performing? In a falling market, lenders tend to take a conservative approach and either reduce the amount they loan to customers or scale back their exposure to home loans in that area.
- Market segment conditions: How would this property fare on the market if it was necessary to sell quickly? If the property is unusual or falls outside the mainstream, or is perhaps in the top five per cent of properties in that area, or is not similar to the bulk of properties sold in that area, the lender may baulk, or have reservations.
- Volatility: Similar to looking at the market microcosm, volatility is a red flag to lenders. This tends to be low-volume areas where sales turnover is low and the market can be volatile. It’s harder to get a loan to buy here as risk factors are higher.
Improving your chances
Understanding the role that risk ratings play in your property valuation, it makes sense to get your own valuation done ahead of submitting a loan application. This will help you avoid disappointment (and unnecessary rejections that may impact your credit rating).
Risk rating might also reveal actions you can take to make your home a more appealing option in terms of risks. Maybe it’s time to attend to major maintenance, or complete that bathroom and kitchen upgrade you started months ago?
Also, understanding what goes into a higher risk rating will help you avoid these properties when making your short list of properties to purchase, whether as an investment or as a principal place of residence.
The information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.