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What Is Fair Market Value (FMV) In Real Estate And How Is It Determined?

Lauren Bowling4-minute read

November 18, 2020

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A home is one of the most expensive purchases people make in their lifetime. As such, buyers, sellers, and investors alike are all very concerned with getting an accurate fair market value of a property. But determining the fair market value is a nuanced process that takes multiple factors into consideration.

Instead of thinking of fair market value as a math formula, picture it as a cake: you’ll need lots of ingredients to bake it just right.

Fair Market Value (FMV) Meaning

Fair market value (FMV) in real estate is the determined price that a property will sell for in an open market. The FMV is agreed upon between a willing buyer and seller, both of whom are reasonably knowledgeable about the property in question.

To determine what fair market value is, it’s better to first look at what FMV isn’t: fair market value isn’t what you (the buyer or the seller) think the value is, it’s not necessarily the appraised price, and it also isn’t the tax value.

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How To Calculate The Fair Market Value Of A Home

Unlike other aspects of buying and selling real estate, there isn’t a defined formula for determining the fair market value of a home. If only it were that easy!

Because pieces of real estate are sold on the open market, the value of these financial assets are subject to the fluctuations of that market. Namely, supply and demand. Because of this, the buyer and seller’s individual circumstances and desire to buy and sell will greatly impact the fair market value of a home. This is why “fair market value” isn’t always what a piece of real estate is actually worth – it may depend upon what it is worth to either the buyer or seller.

With this in mind, here are the following ways a rough FMV can be calculated:

  • A willing buyer and a willing seller agree upon a property’s value based on their reasonable knowledge of the property and current market trends.
  • Comparative market analysis of other, similar properties in the area.
  • Having an appraiser determine the property’s valuation. While not the final word on FMV, the appraised value can often suffice in the event a fair market value is needed. An appraisal also reinforces what a lender will allow a consumer to borrow on a home which often becomes by default an approximation of value on the open market.
  • Calculate a rough price per square foot. Look at comparable homes in your neighborhood then divide by square footage. Then take that dollar amount and multiply by the number of square feet in your home.

Where Else Does Fair Market Value Apply?

Fair market value isn’t just for those buying and selling real estate. Realistically, every current homeowner needs to stay knowledgeable on the FMV of their home, as this not only affects their net worth and the value of the asset itself, but a variety of potential financial concerns, from taxes to insurance.

Insurance Claims 

Homeowners insurance takes into account the fair market value of the home when determining how much to charge for a policy, including how much it would cost to replace the home (in the event of fire or flood, for example.)

This “cost to replace the home” is an important distinction, as replacement cost of a home is determined by current fair market value and not necessarily what you paid for a home.

Remember, fair market value is determined by what the buyer and seller both agree to pay. For example, if you had a homeowner who needed to sell the home quickly to take a job in another state, maybe the buyer paid less than the home’s actual value at that time. Alternatively, if homes in your neighborhood suddenly become very popular, the replacement cost would go up to accommodate for this fluctuation in circumstances.

Taxes 

Fair market value of a home is also used to calculate a homeowner’s property tax bill each year. Each municipality has its own tax rate. For example, if your home is appraised at $300,000 fair market value and the property tax rate in your county is 3%, you would owe $9,000 in property taxes each year.  

Fair market value also affects other taxations where property and real estate are in play: the estate tax, gift tax, and inheritance tax. If an heir receives a home in an inheritance, or as a gift, they’ll have to pay property taxes on the fair market value of the home – regardless of how they came to own the property or someone “gifted” it to them for free.

Legal Disputes 

Fair market value also becomes a very important (and often hotly contested number) when it comes to settling legal disputes: such as during a divorce settlement, when damages are done to private property, or when two heirs are given one piece of property and one needs to buy out the other.

Fair market value keeps all parties on the same page as to the value of any and all shared assets and keeps one party from being able to take advantage of the other.

Bottom Line

Fair market value isn’t just a fancy term that real estate agents made up – it’s a number that impacts everything: from sales to insurance, to inheritance and more. Here are the most important things to know:

  • Fair market value isn’t calculated by a set formula; there are a variety of ways to calculate FMV.
  • The most important characteristic of determining FMV is that a buyer and seller are willing to agree on what a piece of property is worth.
  • Fair market value is also important for calculating property taxes, insurance claims, and settling legal disputes where property is involved.

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Lauren Bowling

The Rocket Mortgage Learning Center is dedicated to bringing you articles on home buying, loan types, mortgage basics and refinancing. We also offer calculators to determine home affordability, home equity, monthly mortgage payments and the benefit of refinancing. No matter where you are in the home buying and financing process, Rocket Mortgage has the articles and resources you can rely on.