house drawn on chalkboard with dollar signs. What is fair market value? (StockFinland)
Whether you're buying or selling a home, one question that's always front and center is the price: How much is a home worth? That's a tricky question to answer, but probably the best starting point is to know a home's fair market value, or FMV.
A home's fair market value is the price it would sell for in a perfectly logical world -- one where both buyer and seller are acting of their own free will (in other words, they aren't desperate to strike a deal), are reasonably aware of a home's good and bad points, and could just as easily choose a different house that suits their needs better.
In such a world, market forces reign. Buyers and sellers negotiate up or down from their various positions and agree on a home's price. Deal done. All is good!
Fair market value vs. market value
A home's fair market value is similar to a home's market value -- what it would fetch on the open market -- but is used in specialized circumstances where the concept of fairness is important to evoke so that the home's price carries more weight.
"FMV is typically brought into the real estate conversation whenever a sales price is being scrutinized," says Robert Pellegrini, a real estate lawyer in Boston. Here are some circumstances where you'll likely hear about a home's fair market value:
- Property tax assessments.
- Home insurance claims -- if a house suffers damage from a fire, flood, or other disaster, the insurer will look to FMV to determine compensation.
- Refinancing a home loan -- the bank will typically use a home's fair market value as a measure of how much the home is worth to determine refinancing terms.
- Estate sales -- if the homeowner has died and a relative wants to purchase the property, the court will look at FMV to determine a price.
- If the government wants to "buy out" a homeowner to use that land to, say, build a highway or school, the owner is typically entitled to be compensated at fair market value.
- Short sale -- this is when a home is worth less than the owners owe on their mortgage. In this case, the owners must persuade the lender to let them sell the home for some amount that is less than the balance of the home loan they still owe. "When a bank does allow this, the bank wants to make sure that the short-selling purchase price is at least FMV for the property," says Pellegrini. Because, of course, no one likes a total loss!
How is fair market value determined?
"Let's be clear about one thing: There is no exact mathematical formula that calculates fair market value," says mortgage lender Michael Fema, CEO of Get a Rate. "Information is key, and the best way to obtain a home's true FMV is … by hiring a professional licensed appraiser."
To determine fair market value, a licensed appraiser gathers and measures the qualities of a home, such as its size, condition, neighborhood, and other factors. This information is used by lenders, attorneys, insurance companies, and other agencies to help determine a fair price.
All that said, no one ever proclaimed that life (or the housing market) is fair -- which is why homes may often sell for an amount far different from this figure.
If, say, a family is desperate to buy a certain home because it's in a coveted school district and their twins are entering kindergarten that fall, they might be willing to pay substantially over a home's fair market value. Or if a home seller has fallen ill and has to sell quickly to cover medical bills, he or she might be willing to settle for less than a home's FMV.
But in an ideal world, fair market value is the benchmark, and probably the closest number to what a home is truly worth.
At its heart, fair market value helps prevent home sellers and buyers from being taken advantage of, and is a good thing for both parties. And it's worth knowing the term in case you feel like someone's stance on a home's price is off base. Just point out, "I think that's pretty far above/below this home's fair market value." Who knows? If you're right, this argument could persuade the seller or buyer to budge.
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