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When buying or selling a home, an estimated fair market value (FMV) typically provides a starting point for setting a sale price. When you seek a mortgage, refinance a home loan or borrow against home equity, FMV is typically used to determine the amount of the loan a lender will extend you. Here's how FMV is estimated, and how it can influence home pricing and financing.
What Is Fair Market Value?
Fair market value is defined as the price an ideal buyer and seller would agree to, assuming no pressing circumstances (no coercion or neither party being desperate to complete the sale, for example) and full awareness on both sides of the advantages and flaws of the item being sold.
Applied to real estate, FMV is an estimate of the amount a home would sell for under current market conditions. Typically calculated by a real estate agent or professional appraiser, FMV is typically based on comparisons to recent sale prices on similar properties in the area.
FMV is influenced by characteristics of a given property, including:
- Square footage of living space in the home
- Number of bedrooms and bathrooms
- Age and condition of the features such as patios, decks and garage
- Age and condition of the home and key components, such as the roof, furnace or HVAC system
- Size and features of the yard
- Unusual property features, such as built-in pools, outbuildings or in-law apartments
What Is Fair Market Value Used For?
In the context of a home sale, fair market value often serves as the basis for setting an asking price. A real estate agent may or may not automatically recommend using a calculated FMV as the listing price, in light of market conditions. In markets where prices are rising amid brisk sales and high demand, for instance, they might recommend an asking price above FMV. In a market where sales are sluggish and home prices are flat or in decline, listing at a discount from FMV might be advisable.
Lenders use FMV to determine a home's worth when issuing new mortgages and mortgage-refinance loans, and to calculate your home equity when issuing home equity loans and home equity lines of credit (HELOCs). If you seek a mortgage or a loan against the equity in your home, the lender will typically require you to pay for a home appraisal, conducted by a professional of their choosing, to determine the home's FMV.
How to Calculate Fair Market Value
To determine fair market value, real estate pros typically look for at least three comparable properties, or "comps"—houses with attributes similar to those of the home in question—that sold in the same area within the past few months.
If all three properties were identical to the house under evaluation, their average sale price would serve as FMV. Of course, no two properties are exactly the same, so adjustments typically are made in light of differences in the properties.
If one of the comps has one and a half bathrooms, for example, and your home has two full bathrooms, the evaluator might pad the comp's sale price. Conversely, if one comp has a finished basement while yours has an unfinished basement, that comp's sale price might be adjusted downward.
The amounts of these adjustments are based on the evaluator's experience and knowledge of what various home features are worth in their local markets. After the comps' sale prices are adjusted to conform with the home in question, they are averaged to provide a fair market value.
If suitable comps cannot be identified—for instance, if a house has unusual features that aren't shared by any other local properties, or if no properties with similar attributes have sold nearby within the last year—a more formal property appraisal typically is hired to determine FMV. Their methods might include:
- Calculating the cost of labor and materials that would be required to build the house from scratch.
- Comparisons to sale prices on properties in other regions of the country, with adjustments for regional differences in property values.
The Bottom Line
Fair market value plays an important role in the pricing of homes for sale in a given community, and in determining how much you can borrow when buying a home or using it as collateral on a loan. If you're considering seeking a mortgage, home equity loan or HELOC, check your credit report and your FICO® Score☉ from Experian to get an idea how lenders will view your application. If appropriate, consider taking steps to spruce up your credit before applying for a loan.