by Christy Bieber | May 9, 2021
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It may seem odd, but there's a simple reason most mortgage lenders require an appraisal.
When you apply to refinance your home loan, you may be surprised if your mortgage lender wants to do an appraisal. This involves having a professional come out to estimate the current market value of your home.
It may seem odd to get a stranger to come to your house and tell you (and the bank) what your home is worth. Especially if you bought it years ago and currently live in it. But there's a simple reason lenders often require a home appraisal: They want to make sure the home is worth enough to act as collateral against the loan. It's how they protect their interests if you don't pay it back.
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A home mortgage is a secured loan. That means there's an underlying asset -- the house -- that guarantees the debt. If you don't pay off your refinanced home loan as promised, the lender could foreclose, sell the house, and get their money back.
The fact that home loans are secured is one reason mortgage rates tend to be lower than other kinds of debt, such as credit cards or personal loans. The lender takes on a bigger risk with debts that aren't guaranteed by an asset.
Lenders typically ask for an appraisal when refinancing to make sure your home is actually worth enough to protect their financial interest. The goal is to make sure your refinance loan doesn't exceed a certain percentage of your home's value, also called a loan-to-value ratio.
For example, lenders may not be willing to lend more than 80%, 90%, or 95% of your home's value. This depends on the type of refinance, your lender's requirements, and your financial credentials.
The appraisal gives the refinance lender an unbiased estimate of what your home would sell for under current market conditions. That way it'll know exactly how much it can loan you while keeping your loan-to-value ratio under the allowable amount. Your home's value may have gone up (or down) since you bought it, so the appraisal is an important step in the refinancing process.
Unfortunately, if your home doesn't appraise for enough money, you may not be able to refinance your loan at all.
On the other hand, if your house appraises for much more than the value of your current loan, you might be able to take a cash-out refinance. That would mean you'd be eligible to borrow more than enough to pay off your current loan. Some people take cash-out refi loans to tap into their home's equity and free up money for other things, such as home improvements. If you're considering going this route, there are some mistakes you should try to avoid.
Your appraisal is likely to cost a few hundred dollars. And for most refinances, you can't proceed without it. The lender wants to be sure the value of your home is high enough to support your loan. So don't count on refinancing until this important task has been completed.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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