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 home buyer and seller are acting of their own free will (in other words, they aren't desperate to make a sale) and are reasonably aware of a home's good and bad points, and where the buyer could just as easily choose a different house that suits her 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: What's the difference?
A home's fair market value is comparable to a home's market value—what it would fetch on the open market—but is used in special circumstances where the concept of fairness is important to evoke so that the home's sales 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 the fair market value of a home:
* Property tax assessments in a specific market are based on a home value and comparable properties.
* Home insurance claims—if a house suffers damage from a fire, flood, or other disaster, the insurer will look to the market value to determine a compensation estimate.
* Refinancing a home loan—the bank will typically use an appraisal of a home's current market value as a measure of the home value to determine refinancing terms for a mortgage.
* Estate sales—if the homeowner has died and a relative wants to purchase the property, the court will look at home value appraisal to determine a price for the sale.
* 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 so that she will sell.
* 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 on a home value!
How is fair market value determined?
"Let's be clear about one thing: There is no exact mathematical formula that calculates this," says mortgage lender Michael Sema, 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 square footage, condition, similar homes in the area, neighborhood, market conditions, and other factors. The appraiser's information is used by lenders, attorneys, insurance companies, and other agencies to estimate a home's market value.
All that said, no one ever proclaimed that life (or the housing market valuation) is fair—which is why homes may often sell for an amount far different from the appraisal valuation.
If, say, a family is desperate to buy a certain home because it's in a certain neighborhood or coveted school district and their twins are entering kindergarten that fall, they might be willing to mortgage a price 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 the home's appraisal.
But in an ideal world, fair market value is the benchmark of property value, and probably the most comparable estimate of 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 sale price is off base.
You could 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 to budge on the sale price.