As was explored in our 2021 Real Estate Predictions article, home prices in Canada have been rapidly increasing over the past year. In many parts of the country, valuations that are set by appraisers are simply unable to keep up with the rapidly growing market.
The problem for homebuyers and home sellers here is significant: the amount that a bank will lend can be significantly less than the asking price, leading many to have to dig into their savings to put more money down in order to get approved.
Appraisals are essentially the valuation of a house at a moment in time, but when a market changes as rapidly as real estate has over the past year, these appraisals can become quickly outdated.
With homes selling for record prices in hundreds of communities across the country, appraisals are falling short of the prices paid. Small and rural communities in particular are seeing huge growth in home prices, with a growing dichotomy between the appraisal and actual sale price.
This can create a financing gap for buyers who are intending on using mortgages to pay for a large part of their purchase, ultimately leading them to having to seek last-minute financing in order to secure the home that they want (Globe & Mail).
Rick Sieb, owner of Intercity Appraisals Ltd. stated in an interview with The Globe & Mail: "Before COVID, I would say we would have one in 50 not match up. I would say right now we're not hitting numbers maybe one in 10." This is 5x more mortgages not being approved, meaning 5x the amount of people not being able to afford new homes.
Before the pandemic, many appraisals were done entirely through data run through automated models. However, most involved an appraiser physically entering and judging the home. Mary Ellen Brown, senior vice president of personal financing products at RBC stated in an interview that both appraisal approaches have been "struggling," and they are "relying less on the automated model" due to home prices increasing so quickly.
Competition in many communities in Canada has become so fierce that certain conditions that would ordinarily allow a buyer to back out of a purchase are now seen as outdated. And with faulty appraisals, home buyers are faced with collecting the required cash as quickly as possible.
When appraisals and prices do not match, banks and mortgage lenders change loans using valuations rather than home prices, meaning that a buyer may not be able to borrow as much as anticipated (Globe & Mail). This results in many buyers digging into their savings or turning to private lenders to close this gap.
Though mismatches between appraisals and home prices are not unheard of, they are typically common in large Canadian cities such as Montreal or Toronto. However, due to the COVID-19 pandemic, smaller communities are becoming some of the country's hottest markets, including Gatineau in Quebec as well as Abbotsford in B.C.
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