Buying a Fixer Upper? Beware This Giant Pitfall

You'd think today's sky-high mortgage rates would've led to a massive drop in buyer demand, thereby bringing home values down. But the National Association of Realtors reports that the median existing home sale price in September was $394,300. That's a 2.8% increase from a year prior.

Because homes today are so expensive, you may be eager to do what you can to snag a lower purchase price. One option, of course, is to look for one in an up-and-coming neighborhood rather than focus your search on neighborhoods that are already well-developed. Another option may be to move to a more rural area with fewer amenities where the average price per square foot is lower than what you'll find in popular cities and suburbs.

But there's a third route you could take to save money on a home purchase, and it's buying a fixer-upper. If you're fairly handy and are confident in your ability to tackle renovations, then it could make sense to spend a lot less on a home and work at your own pace to make it move-in ready. Plus, this way, you'll get the chance to put your own stamp on your home.

While buying a fixer-upper might be a good solution in theory, there's one big pitfall you'll need to look out for if you're going this route. And it's a pitfall that could get in your way of seeing your mortgage go through.

When you run into issues with your appraisal

There are certain steps you need to take to finalize the mortgage process. One is to undergo underwriting, where a mortgage lender takes a deep dive into your finances to make sure you're in a strong-enough financial position to borrow the money you're asking for.

Another step needed to finalize your mortgage is to have the home you're buying undergo an appraisal. And the reason is simple.

Your mortgage lender needs some degree of protection in case you end up falling behind on your mortgage payments. So your lender will want to make sure your home is worth at least as much as the sum you're borrowing. That way, if things reach the point where your lender has to force the sale of your home to get repaid, it can feel confident the home will command a high-enough price to cover your loan balance.

If you're buying a fixer-upper, though, then the property you're looking at may not appraise for a high enough value to satisfy your lender's requirement. And that could result in you losing your mortgage.

Let's say you're looking to buy a $220,000 home and are putting $20,000 down. That means you're aiming to borrow $200,000. If that home only gets appraised at $190,000, your lender isn't going to loan you $200,000. That leaves you with a problem on your hands.

What to do if your appraisal comes back low

When you're buying a fixer-upper, you run the risk of having issues with your appraisal. But you still have options if that number comes back low.

One is to renegotiate your purchase price so you don't have to borrow beyond that home's appraised value. Another option is to put more money down on your home if you have it. So all told, you're not totally out of luck.

To be clear, just because you're buying a fixer-upper doesn't automatically mean that your home isn't going to appraise for the value you need it to. But it's a risk to be aware of nonetheless.

As such, if you specifically have your eyes on a fixer-upper, be mindful of potential appraisal issues. And consider buying a home that's not at the very top of your budget in case you end up needing some leeway after making your offer.