Rest assured, everyone involved does sympathize with you. Also rest assured that the house is not being penalized for having some of the finished living space in the basement (below grade area). Indeed, everyone is conscious of the issues involved. As home sellers and homebuyers become more savvy, all have become aware that square footage is a key factor in the sales price. Understandably then, the seller wants as much counted as possible while buyers do not want to pay for something they didn’t get. So, while the whole process is confusing and appears arbitrary, there actually is a method to the madness.

What started the whole business was the Federal National Mortgage Association, which goes by the acronym FNMA, but which some creative Washington wit has dubbed "Fannie Mae." Fannie Mae is the reason that you can easily sell or buy a house. Why? Because this quasi-governmental organization was established to buy individual mortgage notes from lending institutions and then package blocks of mortgages into single securities instruments for sale to investors. But, to be able to do this, the entire lending industry had to change the individualistic way it did business.

That is, in the "old days," mortgage loans were made primarily by Savings and Loan institutions which were operated from one location in the community and had long-term staff and officers who knew the community very intimately. Each of these S&Ls made loans based upon their own loan standards and as often as not, their personal knowledge of the borrowers. The S&L made loans and kept them on the books for 20 or 30 years. Therefore, unless deposits grew, the number of loans any one S&L could make was limited. 

Then Fannie Mae came along and said, "we’ll buy your loans, thus returning your capital (at a profit) so you can go out and make other loans"--Practically an instant success because this made mortgage loans available on an unprecedented scale. This in turn made it easier to buy and sell houses and the real estate industry was transformed; this included the birth of the residential appraisal industry as we know it today.

However, there was a price to pay. In order to package mortgage notes into a homogeneous block, all had to be written using the same guidelines for loan-to-value ratios, for income ratios, for credit worthiness, and for how a house was measured, and so forth. Thus the phrase conforming loan was created. Don’t confuse this with conventional loan. The phrase conventional loan is used to indicate that the loan is not FHA or VA backed. 

So, Fannie Mae, not knowing a barn from a basement, asked the American National Standards Institute (ANSI) how to measure square footage. ANSI said, in effect, OK, since the majority of basements in the USA are surrounded with dirt (below grade), and have no windows, they are basements regardless of what’s there and we don’t care if there are exceptions because we want a one-size-fits-all standard."

Therefore, everything above grade was to be counted as Heated Living Area (HLA) if finished (walls, floor, and ceiling), heated from the same source, and is all connected. How to measure these areas was made relatively easy. Measure around the perimeter and include everything inside; halls and closets, even the dead space inside the studwalls. Above grade laundry rooms and furnace rooms are included as long as they are heated, finished, and attached.

The stairway from the first floor to the second is basically counted twice, once for each floor; the way to conceptualize this is to think of the stairs as part of the second floor and think of the space below the stairs as storage for the first floor—the important criterion is that both spaces can be used (ignore the fact that there is not much useable space at the back of the understair area). Following this logic, atriums or two story open areas next to stairs can be only be used for one of the floors, so these areas are only counted once. Apply the same yardstick to cathedral and vaulted ceilings. This is basically how everyone measures HLA. Note that while some of this might not seem to make sense, the idea was, make it as simple as possible. If, for example, we measure studwall cavities for everyone, then everyone gets the same credit. Now, while there are some other minor "how-to’s", if you understand the above, you have mastered the basics.

However, just when you thought it was getting simple, we move on to the so-called bonus room over a garage or in an attic. Just like basements, homeowners and builders "discovered" that these areas provide cheap ways to expand space. So, the first criterion for including this space is whether or not it is accessible through finished space. If not, it’s not part of the counted square footage, but rather, is a bonus room. 

Then getting past that, comes the issue of height—less than 84" (seven feet) and it’s bonus area, not heated living area. That part is pretty logical; any thing under seven feet and you would feel like you are in cave. There is also a certain logic here; buyers will look at a low ceiling area and say, "whoa, I don’t like that, I may buy the house, but I’m not going to pay full market value for that portion."

However, here’s the hard part. Attic areas and rooms over garages have sloped ceilings. According to ANSI and some State Real Estate Commission guidelines, the average height of the room has to be at least seven feet. In other words, get out your high school geometry text book. Here’s the problem: (a) the flat part of the ceiling is generally eight feet, (b) the side walls are generally five feet, and (c) the sloped part obviously then goes from five feet to eight feet. Now, all the agent or appraiser has to do is come up with the answer. Right?

We won’t torture you with the figuring out the "answer" because there is not any one easy answer. The important concern is that everything depends on the pitch of the roof. Given two rooms with the same floor plan, but with different slopes (pitch), one room could be included in Heated Living Area, while the other would only be as counted as a bonus room. Why? Because the steeper the pitch, the more area there will be over seven feet. 

So, what’s a Real Estate agent or Appraiser to do? Well, if the agent works in an area where the rule is rigidly applied and he or she ends up with a "bonus" room instead of space added to the advertised square footage, he or she bites the bullet, cringes, and tells the soon-to-be unhappy homeowners they have 264 square feet less than they thought. On the other hand, your happy-go-lucky Appraiser does not have the same dilemma because he or she has more latitude (within the access and height constraints) to use judgment and determine whether the room’s functional utility makes it a bonus room or part of the heated living area (this goes back to the "whoa, this feels like a cave" concept). The vast majority of Appraisers are not going to split hairs on this issue and will include most so-called bonus rooms (but not all) in total heated living area.

Now, getting back to standardizing loans, Fannie Mae also devised a form that was to be used for all conforming loans. This form is the cause of the above grade/below grade debate. It is called a Uniform Residential Appraisal Report (URAR). The URAR, the primary form used by appraisers and mortgage lenders to define and value a residential property, is two 14 inch pages. Approximately half of the second page is devoted to physical descriptions of your property and three other properties we will use for comparison purposes. Of this space, approximately ½ inch is devoted to describing below grade space. In other words, the appraiser is not encouraged to focus on below grade spaces. However, don’t worry; appraisers have gotten pretty creative when using that ½ inch to describe finished basement areas.

This philosophy that the basement doesn’t count much  works OK in the north where land tends to be flat and basement areas tended to be there only because frost lines required digging deep foundations--nice place to put the furnace and washing machine (the mother-in-law came later). 

In flat areas of the south and west, there is no issue because basements generally are not built. However, in areas that are not flat, basement walls tend to be half below grade and half above grade (typically called walkout or daylight basements—yet they are still thought of as basements by ANSI and Fannie Mae. But, things have changed from the infamous paneled basement rec room that homeowners added in the 50s and 60s. Builders have decided that below grade space is too precious to devote to a furnace and washer/dryer; so, now in goes window wells to create sunlight, a bedroom, bath, and family room—all of quality equal to the above grade space.

Thus the debates: Appraisers have to use the URAR; real estate agents do not. So historically, agents have generally taken the common sense approach and said, "well, its finished and I’m counting it." Then, because Fannie Mae says so, the appraiser comes along and uncounts it. No wonder buyers and sellers ask that question, what do you mean it doesn’t count?

Actually, there is no real debate. Both Real Estate agents and Appraisers are trained to determine market value of a given home by looking for at least three homes that sold recently that are as similar to the subject as possible. These recent sales are called comparables—comps for short. The ideal comp is exactly the same (age, number of stories, garage, lot size, neighborhood, and so on). Of course, the perfect comp does not exist, but that is where the art comes in. 

Now, getting back to the finished basement and bonus areas. Competent Appraisers and Real Estate agents will look for comparables with similar areas above and below grade. And, ideally both used the same comps. They just add the space up differently. An appraiser will look closely at the 2000 square feet that the real estate agent advertised, see that it is 1000 square feet with one story above grade, 1000 square feet below grade, and will look for one story comps that have above and below grade finished space (and will not use a two story comp with only above grade finished space). So, while the Appraiser keeps slicing apples, but the Real Estate agent has been peeling oranges, just think of it as two different cooks mixing up the same fruit salad—it all fits in the same sized bowl.

About the author: John C. Williams operates his business, WNC.RE.Source, Inc. in the Asheville, NC area of western North Carolina. John is a licensed Appraiser, Home Inspector, Real Estate Broker, and General contractor. He can be reached at 828.628.2727 or 2727@home.com

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