Home appraisals are a vital and important step in financing a purchase, refinancing an existing mortgage, or obtaining a home equity line of credit. Here’s an overview of what you can expect and how appraisers come up with their numbers.

You know what you paid for your home and how much the house next door costs. You know what you’ve put into renovations. But what you may not know is how much a lender is willing to finance if your house is for sale, if you’re in the market to refinance, or if you’re considering adding a home equity line of credit (HELOC). That’s where an appraisal comes in. Appraisals can also be used to divide property during a divorce or estate settlement, determine a home value in order to remove mortgage insurance, or set a value for tax purposes.

In real estate transactions, appraisers determine a property’s fair market value, which is the most likely price for which it would sell in a free market. The lender then uses this information to determine how much to lend against the property, whether it’s an outright sale, a refinance, or a home equity. If you aren’t familiar with the appraisal process, it helps to see how professionals arrive at the numbers that help lenders arrive at a figure. Here’s a look at how they work.

The Basics

Since the government controls how appraisals are conducted, they’re awash in regulations. As a general rule in selling a home, the appraiser is hired by the lender and the lender passes the cost along to the buyer, usually in the application fee. In a refinancing or when obtaining a home equity, the homeowner pays for the appraisal.

An appraiser compares the sale price of a home with that of similar homes that have recently sold in the same area. These are called comparables. Although there is no set rule, when a lender agrees to finance a mortgage, he wants to see a minimum of three comparables. Appraisers try to make an apple-to-apple comparison. For example, an appraiser would not contrast a 1,700-square-foot ranch with a two-story Cape Cod that’s twice the size.

The cost of an appraisal varies by region, but a buyer should reasonably expect it to add $300 to $500 to closing costs. A homeowner who refinances or adds a second mortgage may be asked to pay the fee up front.

Appraisals Estimate Value

John Bredemeyer of Realcorp, an Omaha appraisal firm, says the appraisal is not an analysis of the agreed-upon sales price but an opinion of the property’s value. “The price is the part that the buyer and seller agree on, and it can be the same as, higher than, or lower than the market value,” he says. The appraisal, on the other hand, is an estimate of the most likely price the property would fetch under normal market conditions and it is used to determine how much money the owner can borrow with the house as collateral.

A real estate appraiser inspects the property, but this step isn’t the same as a home inspection commissioned by a buyer. An appraiser estimates a home’s value while an inspector looks at its physical condition. Both an appraiser and inspector check out the inside of the home, but an appraiser is there to verify the number and types of rooms, floor plan, square footage, age, general condition, and listed amenities. An appraiser may measure the rooms and lot, noting the location as well as obvious defects. Inspectors report on both large and small problems. For example, while an appraiser would not check electrical outlets to make certain they are working, an inspector would.

The Appraisal’s Too Low—Now What?

What if the property appraises for less than the amount you’re hoping for? Bredemeyer says you can challenge the appraisal by presenting additional information. Consider having your real estate agent put together a package of comparables that weigh in your favor or point out amenities that might have been overlooked. There’s no guarantee you’ll receive an adjustment on the appraisal, but it’s worth trying.