Here in Salt Lake City when you use a mortgage loan to purchase a home, the lender will require that an independent appraisal be done on the home before the loan is finalized. Because of this requirement there is a contingency in the Real Estate Purchase Contract that states the buyer can cancel the contract if the home appraises for less than the agreed upon purchase price.
Why is the appraisal necessary? The appraisal is needed because the lender wants to make sure that the collateral you are using to secure the loan is worth the amount of the loan. If you end up defaulting on the loan and the lender has to foreclose, they want to make sure they can recoup their loss when they sell the property in a foreclosure sale.
If the house appraises for exactly what you are buying it for - great! You aren't overpaying and the lender is protected. If it appraises for more than the purchase price - even better! You get some equity in the home right away. That's always nice.
If the home appraises for less than the purchase price, this is where there are some options for you. As the buyer you want the value to be the same or more than the price. The lender wants the value to be at least the amount of the loan. So if you're buying a $200,000 house, putting $40,000 down and borrowing $160,000, the lender wants the value to be at least $160,000. If the appraised value comes in between $160,000 and $200,000, you as the buyer have a few options according to the purchase contract. 1. You can cancel and walk away and have your earnest money refunded, 2. You can try to renegotiate the price of the home with the seller, or 3. You can buy the home anyway. If you do this, you may have to come up with addition cash for you down payment to satisfy the lender's requirements.
How do you avoid getting a low appraisal? This isn't 100% in your hands unfortunately. Federal regulations enacted after the 2008 crash require an independent appraisal. The best way to help ensure a good appraisal is to do your homework before you even write an offer on a house. This is where a great real estate agent can earn their keep. For my buyers I will pull up comparable homes sold in the last six months to determine the home value. I will look at the same pool of homes the appraiser does. In my years of experience I have only had had problems with two appraisals after doing this homework. And the times I had problems, I knew it would be tight because of the research we had already done. And even then, my clients didn't lose the deal. So even though we can't steer the appraisal (which is a pretty good regulation in my opinion), we can make educated offers.
That in a nutshell is why appraisals are needed in a real estate transaction. If you have questions I'd love to help. Reach out and let me know.