Rising Home Prices Are Causing Mortgages to Fall Through

Inflated housing prices don't just force buyers to spend more -- they can also put their home loans at risk.

Buying a home is a challenge in today's market. Not only is real estate inventory limited by over 5 million homes, but home prices have soared over the past year. Now, buyers are being forced to take out larger mortgages to cover their costs.

Inflated home prices aren't just costing buyers more money. In some cases, they may be causing mortgage loans to fall through.

Why rising home values matter with a mortgage

When you get approved for a mortgage, there are different steps your mortgage lender needs to take to finalize that loan. For one thing, your finances will be further examined through a process known as underwriting. Your lender will also need reassurance the home you're looking to buy is worth enough to cover the amount of your mortgage. That's where home appraisals come into play.

During an appraisal, a professional will inspect a property and determine what its value is based on its condition and local home values. A big reason home prices are so high right now is that demand is high, and buyers are frequently entering into bidding wars, which drive prices up.

To put it another way, today's high home prices aren't necessarily reflective of homes' actual value. And that's something that can come through during an appraisal.

In August, about 13% of home appraisals came in below their sale price, according to CoreLogic. In May, nearly 20% of appraisals followed a similar pattern. When homes don't appraise for a high enough value, a mortgage can easily fall through.

Mortgages are secured loans, which means they're backed by a specific asset -- the home that's being purchased. If a lender is giving out a $300,000 mortgage for a home but its appraisal comes back at $290,000, that mortgage could fall through because $290,000 won't be enough to allow that lender to get repaid if the borrower stops paying their mortgage. When you have a housing market with inflated home prices, low appraisals are likely to be more common.

What to do if your home appraisal comes back too low

If you're buying a home and it doesn't appraise for a high enough value to cover your mortgage, then you have some options. First, you can make a higher down payment and borrow less, if you have the cash to do so. Second, you can go back to your seller and try negotiating the home's price downward. That's something your seller may or may not agree to, though. If neither option works, you may have to walk away.

Home appraisals are designed to protect mortgage lenders. But they can protect home buyers, too, because purchasing a home for a price that's way above its actual value could hurt you financially.

Say you pay $350,000 for a home that's really only worth $310,000, and then you unexpectedly need to sell it two years after you buy it. At that point, the home's value could fall significantly below your purchase price, which means you could lose money in a sale.

It's important to pay attention to what an appraiser says about the home you're looking to buy. If a home doesn't appraise for enough money to cover your mortgage, it's a sign you may be better off walking away from the deal.