The one thing many people dread about refinancing is the home appraisal. Why is it necessary when the bank originally loaned you money to purchase the home? The appraisal is actually one of the most important factors for loan approval according to the lender. Without adequate value in your home, the lender could put itself at risk for default. What would keep you making your payments on a home which lost its value? If you owe more than it is worth, you might just walk away from the home. Aside from protecting the lender, though, there are several other reasons the appraisal is important.
Determines How Much You Can Borrow
There are several reasons to refinance a home: secure a lower interest rate, lower your mortgage payment, obtain a fixed rate rather than an adjustable rate and take money out of the equity of your home. Refinancing strictly the outstanding principal on your current mortgage does not depend as heavily on an appraisal as does a transaction where you want to take cash out of the home. The lender uses the appraised value of the home to determine how much loan you can obtain. For example, cash-out loans typically max out at 80% loan-to-value ratio. If the appraiser values your home at $300,000, this means your loan cannot exceed $240,000. If your current mortgage has an outstanding balance of $200,000, this leaves you with $40,000 cash out.
The appraised value affects other loan types as well. If you wish to refinance from an ARM to a fixed rate loan, the lender needs to know the value in the home. Even though the fixed rate loan is less risky than the ARM, the new lender needs to make sure the value is in your home so they have collateral. This protects the lender if you were to default on your loan in the future. If the value of your home exceeds your current loan amount, the lender has nothing to fall back on if you defaulted on your loan.
The Home Appraisal Helps You Avoid PMI
PMI, or Private Mortgage Insurance, is a premium borrowers must pay if they borrow more than 80% of the home’s value. Most borrowers wish to avoid this premium since there is no return on their investment for it. If you currently pay PMI, refinancing is a great way to eliminate it. But, the lender has to see the value of your home himself and determine the loan’s value compared to the home value. For example, if you borrowed $200,000 and the value of the home you purchased equaled $240,000 you would pay PMI on a conventional loan. Let’s say it has been three years since you purchased the home and you know values increased. A new appraisal can prove the new value – let’s say it is now $275,000. Even if you did not pay very much principal down on the loan, you would still be below the 80% threshold and could avoid PMI.
Helps You Secure a Lower Interest Rate
The appraisal can even help you secure a lower interest rate on your loan. No matter your reason for refinancing, whether you need cash out or you just want to lower your payment, the lower your LTV, the lower the interest rate. Lenders look at higher LTVs as a higher risk. When a borrower does not have enough invested in a home, they are more likely to default. When you have a larger amount of money invested, whether you physically put the money in yourself or the home value appreciated, the motivation is there to continue making your payments rather than walking away from the home.
Because you pose a lower risk with a lower LTV, the lender will often reward you with a lower interest rate. Generally, borrowers with higher LTVs have rate adjustments which make the loan more expensive. If you know your value increased, it is worth paying for the appraisal to help you save thousands of dollars in interest over the life of the loan.
Increases Your Chance for Approval
Loan approvals are not very easy to come by these days. With the implementation of the Qualified Mortgage Rules, many lenders tightened their strings on what they offer borrowers. Those on the verge of “good” and “risky” often find themselves without a loan approval. The home appraisal, however, can bridge the gap between good and risky. For example, if you have borderline credit and debt ratios, but your home value comes back at a much higher value than its original value, you have the compensating factor of a lower LTV. Compensating factors often help borrowers who would otherwise be turned down for a loan, secure the approval they desired.
The Exception to the Rule
There is one exception to the importance of the home appraisal – streamline refinances. Both the FHA and VA offer this type of loan where you do not have to verify your income, assets or the value of your home. These loans are not cash out loans; they strictly enable borrowers to lower their interest rate and save more money every month. These programs do not require an appraisal because the borrower must lower their interest rate, making the loan more affordable. As long as you can prove you made your housing payments on time over the last year, most approved lenders will provide a loan without an appraisal.
The home appraisal may seem costly up front and like a thorn in your side when it comes to determining your loan amount, but it can help in many ways. Making the small investment now in the appraisal can secure you a larger loan amount, lower interest rate, and even eliminate PMI. It is worth finding out what your home is worth in an official manner, rather than relying on the quotes you may find online. The appraiser will truly value your home based on its condition, improvements and the appropriate comparable homes which sold in the last six months in your area. Consider the appraisal an asset in your home loan process and embrace the possibilities it provides!
