Collateral takes into account what asset a loan is tied to. First time home buyers do not own other property so there is no way to “cross collateralize” a loan or tie it to several properties. This means that the value of the property they are purchasing must warrant the loan they are applying for. A lender will only lend up to 80% of a property’s appraised value (the other 20% must be made up as down payment, mortgage insurance, or a 2nd mortgage). The most common issue when it comes to collateral is the value of the property coming in short. This means that the real estate appraiser’s valuation of the property is less than the contract price that the buyer and seller agreed upon. In this case there are several things that may happen. See example below:
Sales Price: $250,000
Down payment: $50,000 (20%)
Loan Amount: $200,000
Appraised Value: $240,000
Difference: $10,000
In this example there is a $10,000 difference in the appraised value and the sales price. A lender will only loan up to 80% of the appraised value of the property $240,000 x .80 = $192,000. The buyer now needs to come up with an extra $8,000 ($200,000-$192,000=$8,000) to make up the difference. This is where your realtor once again steps in a tries to negotiate on your behalf. The buyer may need to come up with the extra $8,000, the seller may drop their price to $240,000, the seller and buyer could split the difference, or the buyer can walk away from the property. When the real estate market is trending upward it is less common to see appraisals come in less than the contract price. In a down market, short appraisal can be more of an issue.