Overview

Lenders assess collateral to estimate how much they can recover if a borrower defaults. That estimate directly affects loan size, pricing, covenants, and monitoring requirements. To reduce model risk, underwriters typically triangulate several valuation methods rather than rely on a single number.

Key valuation methods lenders trust

  • Market (Sales Comparison) Approach: Uses recent sales of comparable assets to estimate fair market value. Common for residential and commercial real estate; requires adjustments for size, condition, and location.

  • Income (Discounted Cash Flow or Capitalization) Approach: Forecasts future income streams and converts them to present value using a discount rate or cap rate. Used for income-producing real estate and going-concern businesses.

  • Cost (Replacement) Approach: Estimates the cost to replace or reproduce an asset minus physical depreciation and functional obsolescence. Often applied to specialized property, new construction, or unique equipment.

  • Liquidation (Forced-Sale) Value: Projects proceeds from a rapid sale under distressed conditions. Lenders use this to set conservative recovery expectations and haircuts for collateral subject to rapid price drops.

  • Appraisals by Accredited Professionals: State-certified appraisers or accredited business valuers produce formal reports following USPAP standards and lender guidelines. Appraisals add credibility required for larger loans (see Appraisals and Their Role in Mortgage Underwriting).

  • Automated Valuation Models (AVMs) and Broker Opinions of Value (BOVs): Faster, lower-cost estimates used for smaller loans or initial underwriting. AVMs are useful for screening but less reliable in thin or volatile markets.

  • Business and Intangible Asset Methods: For loans secured by a business or IP, lenders use asset-based, market-multiple (e.g., EBITDA multiples), or DCF methods plus expert opinions for patents, software, or trademarks.

How lenders apply valuations in underwriting

  • Loan-to-Value (LTV) and Haircuts: Lenders apply LTV limits and additional haircuts (risk adjustments) to conservative collateral values to build a recovery margin.

  • Stress Tests: Underwriters stress inputs—falling rents, longer sale times, higher cap rates—to measure loan resilience.

  • Documentation & Title/Condition Checks: Lenders require appraisal reports, photos, maintenance records, surveys, and clear title evidence before closing.

Who performs valuations

  • Real estate appraisers (state-certified for most mortgage work).
  • Business valuation specialists (CVAs, CPAs with valuation credentials).
  • Equipment appraisers or auction specialists for specialized machinery.
  • Internal credit officers using AVMs for small-balance loans.

Timing and revaluation

Lenders often require recent valuations—typically within 90 days for real estate or before closing—and may require periodic revaluations for ongoing loan monitoring or post-disbursement collateral declines.

Practical tips for borrowers

  • Update appraisals before major financing events and keep maintenance/insurance records handy.
  • Provide comparable sales, leases, or revenue histories to speed review.
  • For business collateral, supply financial statements, projections, and customer concentration data to support income-based valuations.

Common mistakes lenders and borrowers see

  • Relying on a single valuation method without cross-checks.
  • Using stale or poorly documented appraisals.
  • Overestimating liquidation proceeds for specialized assets.
  • Ignoring title encumbrances, liens, or regulatory restrictions that reduce marketability.

Short examples

  • A bank underwriting a commercial mortgage uses an appraiser (sales comparison and income cap rate) plus an internal stress test to set an LTV of 65% on the lower of appraised or market value.
  • A lender financing equipment uses a liquidation value from an auction specialist and applies a 40% haircut to set the advance rate.

FAQs (brief)

  • Which valuations are required for home mortgages? Most lenders require a state-certified appraisal; the CFPB outlines appraisal requirements and consumer protections for mortgage applicants (CFPB).
  • How often should collateral be reappraised? Before major capital events and whenever market volatility or covenant triggers suggest value risk.

Professional disclaimer

This article is for educational purposes and does not replace advice from a licensed appraiser, attorney, or lender. For transaction-specific guidance, consult qualified professionals.

Authoritative sources

  • Consumer Financial Protection Bureau, appraisal and mortgage guidance (CFPB).
  • The Appraisal Foundation, Uniform Standards of Professional Appraisal Practice (USPAP).
  • Internal Revenue Service guidance on valuation in tax contexts (IRS Publication 561).

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(Information current as of 2025.)