Before you complete the purchase of your new home, your bank or lender will value the property to determine the market value, right? Wrong! While it’s true that when you apply for a mortgage, your lender will set a value for the property you’re buying, the figure they come up with is not necessarily an accurate representation of the property’s value.
So what makes a bank valuation different?
“Banks are willing to become business partners with property investors so that you both can achieve something you couldn’t do without the other, but their support is not unconditional,” explains Bernard Kelly from Retire Laughing.
“Novice property investors often expect a bank valuation to mirror the market price," Kelly says. "In fact, a bank valuation is only an internal control tool, which reflects what a bank can reasonably expect to recoup should it need to repossess and sell the property in distressed circumstances. This is why it’s less than market price.”
Generally, banks will value the property at the lower end of the scale, because they want to protect themselves: If you stop making your repayments and they’re forced to sell the property to recover the money they’ve lent you, they want to be satisfied that they’ll be able to cover the debt, as well as extra expenses like real estate commissions and legal fees.
Occasionally, banks may also apply conservative bank valuations if they change their internal policy, and decide they want to “move away from the total amount that they lend for housing”, Kelly confirms. “It happens from time to time.”
You only need to think back to the depths of the global financial crisis to find an example, as lending criteria changed virtually by the day as banks scrambled to keep quality loans on their books.
While banks may veer towards conservative values, the valuation put on a property by an insurance company is often above the market value, Kelly adds.
“For insurance purposes, a valuation simply reflects what the insurance company would reasonably expect to pay out should the property need replacing – for example, if it was to be destroyed by lightning in say two years’ time,” he says.
As such, insurance companies will often factor in a bit of a "cushion" to keep in step with potential inflation or changes in the country's CPI, as well as potential increases in the cost of construction.
“As you can see, valuations are tools the big corporates use for their own purposes,” Kelly says. “You should always keep in mind that they only loosely relate to the real market price.”