How Is Fair Market Value of Homes Calculated?

Written by Banks Editorial Team
5 min. read
Written by Banks Editorial Team
5 min. read

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When you buy or sell a home, you’ll hear the term “fair market value.” Buyers and sellers use this valuation to determine optimal asking prices. Buyers will want to acquire a property at or below fair value, while sellers will want to exit at or above fair value. Real estate investors use various models and factors to calculate fair market value. Each buyer and seller can arrive at a different opinion, but you need to determine the parameters you will use to determine fair market value. 

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What Does Fair Market Value Mean?

Fair market value is an appropriate price point for a home. The fair market value influences which party got the better deal. If a property’s fair value is $500,000, buyers will overpay if they spend $600,000 on the home. Some buyers have to overpay for a property during a seller’s market. Overpaying may represent the only path to homeownership as buyers outbid each other. Sellers may have to settle for a purchase price below fair market value if few buyers are in the market.

How Fair Market Value Works

Each person assigns value to something. For example, you can buy some T-shirts for under $10, while other T-shirts cost over $50. You may not understand why anyone would spend over $50 on a T-shirt, but some people really do spend that type of money on a T-shirt. Sellers assess their product’s value and market demand when setting price points. Property sellers use fair market value as a price point gauge. Sellers may set their property price above fair market value to create a margin of safety during negotiations. As a buyer, it’s your choice to agree or disagree with the price. If enough buyers don’t budge, a seller may lower the price. 

Eventually, a knowledgeable buyer and seller reach an agreement, and the property exchanges hands at fair market value. A savvy buyer may get a better deal from a seller who doesn’t know the appropriate fair market value, while a savvy seller can sell the property well above the asking price to an unknowing buyer. 

Who Determines Fair Market Value?

The real estate market determines fair market value through buyer and seller interactions. Both groups will look at recent property transactions, market trends, and other variables to determine fair market value. A home appraisal can establish fair market value, but two home appraisers may assign different valuations for the home. 

Home’s Fair Market Value vs. Market Value vs. Assessed Value

Fair market value looks at a home’s fundamentals. A fair market evaluation considers square footage, location, condition, and other factors within the underlying property. Fair market value serves as a great starting point, but not every property sells at fair market value. We often see this trend in the stock market, where some stocks are undervalued or overvalued. As a result, two analysts can present convincing stock valuation arguments that directly contradict each other. This phenomenon also applies to real estate.

Market value reflects supply and demand. A housing shortage will make each available house more valuable. Consumers will aggressively compete to buy a home before shortages get worse. Fewer people buy homes during a recession, but some homeowners don’t have enough time to wait for an economic recovery. Fewer buyers often translate into a home market value below fair market value.

You can get an appraiser to assess your home and come up with a valuation. You can keep this number in mind when negotiating with buyers, but each appraiser has a different opinion. The second appraiser may value your property at $20,000 more or less than the first appraiser’s valuation. Many people interpret the appraiser’s valuation as fair market value. An appraiser’s valuation impacts your property taxes. 

Why Is a Home’s Fair Market Value Important?

A home’s fair market value can change people’s lives. It impacts how much you spend on a home and your proceeds after a sale. However, some significant details about a home’s fair market value are less obvious.

Home’s Listing Price

A home’s fair market value influences the listing price. Many buyers and sellers recognize how fair market value impacts listing prices. Supply and demand can sway the price towards one party’s favor, but fair market value acts as the anchor. A home with a current fair market value of $1 million won’t sell for $100,000. It may not sell for exactly $1 million, but the final price is usually close to fair market value. You can get an offer on your home through OfferPad. OfferPad makes cash offers on homes, allowing sellers to transition to the next chapter of their lives quickly. OfferPad can give you a free offer with no obligation.

Taxes

States use a percentage of your home’s value to calculate property taxes. The average property tax rate in 2020 was 1.1%, but each state and county have different percentages. You can’t escape property taxes since every state has them, but you can get a better deal in some states than in others. In any state, a higher appraised home value will increase your taxes. If your home’s value increases by $50,000, you will owe additional property taxes based on your state and county’s rates. Using the 1.1% average rate in the U.S., you would owe an additional $550/yr in property taxes on a $50,000 gain.

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Insurance Claims

A rising, fair market value hurts at the moment but can help during an emergency. Insurance companies use your property’s fair market value to determine premiums and replacement costs. A higher home valuation increases your monthly expenses, but if your home gets damaged or destroyed by an incident covered in the policy, the insurance company restores or replaces your home, so it’s back to fair market value. Insurance companies luckily look at fair market value instead of the price you bought your home when replacing or restoring it.

Mortgage Loans

Most buyers use a mortgage to finance their homes. A higher fair market value forces borrowers to take out bigger loans to cover the difference. Buyers will have to make more interest payments over the loan’s lifetime, assuming they get the loan. A higher property valuation can make banks nervous about giving the necessary funds to a low-credit borrower. Large loan amounts and high-interest rates can decrease the buyer pool and force sellers to lower their prices.

Investment Assets

The fair market value applies to every asset. You can calculate a stock’s fair market value before purchasing shares. Some investors set limit orders which automatically buy stocks once they hit a specific market price.

Some legal disputes require you to sell your home, and both parties will look at the home’s fair market value as guidance. You may have to sell your home during a divorce or other legal dispute. A house’s fair market value will impact how much money you split with your divorced partner. 

How Fair Market Value is Calculated

You can use multiple processes for calculating a home’s fair market value. Most buyers and sellers listen to multiple opinions and try several models before settling on a favorable fair market value. You can use the following strategies to determine a property’s fair market value.

Do a Market Analysis

You can look at homes in your local market and see how much they sold for in the past. Using recent sales can help you establish a fair market value for your home.

Use Online Estimate Tools

Online estimate tools will guess your property’s value based on the parameters you provide. Some online estimate tools can quickly pull information from their database to determine a fair market value for your home. Some of these online estimate tools also provide free offers. So if you want a quick offer on your home, you may want to give Offerpad a try. 

Get a Comparative Market Analysis

A comparative market analysis considers everything that can impact your home’s fair market value. You can use the surrounding school systems, amenities, parks, and other local components. Buyers and sellers can also look at recent sales of similar homes, a home’s flooring, and other details. Comparative market analyses can lead to disagreements between the buyer and seller.

Order a Home Appraisal

An appraiser can walk through your home and assign a fair market value. You can decide whether to use the appraiser’s value or opt for a different amount, but it provides negotiation leverage if the conversations fall out of your favor. You should declutter your home and polish it up before hiring an appraiser.

Get a Home Inspection

A home inspector can discover problems you might miss. Most buyers hire an inspector to look over the property before purchasing the home. Any significant issues can lower the property’s fair market value or lead to concessions. 

Check Your Tax Assessments

Homeowners get taxed based on a percentage of the home’s value. You can review your tax assessments to see how tax officials value your home. Tax officials use an assessment rate to determine how much taxes you’ll have to pay. If your tax assessment rate is 70%, you’ll pay property taxes on 70% of your home’s value. A fair market value of $500,000 implies a tax assessment value of $350,000. You can reverse this equation to determine a home assessed at $350,000 is worth $500,000.

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