Is an Appraisal Mandatory for a HELOC?

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If you have equity in your home, you may want to tap into it at some point. Before you do, though, you’ll likely need an appraisal. Lenders need to know how much your home is worth before they can decide if you have equity in your home. Luckily, there are other options aside from the full-blown report an appraiser writes after a complete inspection of your home. We discuss them below.

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The Reason for the Appraisal

First, you should understand why a lender requires an appraisal for a HELOC. They use this value when determining how much you can borrow. In addition to the home’s value, they’ll need the amount of your outstanding principal.

Let’s say the appraiser states your home is worth $300,000. You also have an outstanding balance on your current mortgage of $150,000. You currently have a 50% loan-to-value ratio. Most lenders allow a HELOC for an LTV between 80 and 85%. In this case, you’d have 30-35% of equity available for use. This means $90,000 to $105,000. Most lenders won’t allow an LTV higher than 85%.

The Types of Appraisals

Lenders can use their own discretion when determining the type of appraisal you’ll need. You may hear lenders say they require a full appraisal, drive-by, or automatic valuation.

A full appraisal is the same type you likely had done when you bought the home. An appraiser comes out to your home and inspects the interior and exterior. They look at the condition of the home. They also look for upgrades. They’ll look at your basement to see if it is finished. They’ll look for upgraded cabinets, flooring, and woodwork. They’ll also look at the exterior of the home to determine its condition and any upgrades you performed.

The full report lets a lender know without a doubt what your home is worth. The appraiser compares it to homes similar to yours that sold within the last 6 months. This gives a lender the most up-to-date information regarding the value of your home.

A drive-by appraisal only requires the appraiser to drive by the home, as the name suggests. However, most appraisers do get out of the car and take exterior pictures of the home. The largest difference is the appraiser does not enter the home. He simply makes sure the house looks as if it is in good repair from the exterior. Of course, if he has reason to believe the house is not kept up, he may report this back to the lender. The lender may then require a full appraisal report based on his findings.

An automatic valuation is the simplest version of the appraisal. It usually doesn’t cost borrowers anything. Lenders use a software program that they own to determine the value of your home. Think of a more sophisticated version of what you’d find on Zillow. The program determines the value of your home based on the information the lender provides as well as the comparable sales in the area.

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The Benefit of a Low LTV

You might think an appraisal is just another cost that you don’t want to pay. But, you may want to reconsider it. The lower your LTV, the higher your likelihood of approval. Just because many lenders allow up to an 85% LTV doesn’t mean they always approve it. A lower LTV means a lower risk of default in many cases. You may have a higher likelihood of approval the more your home is worth. If you know your home appreciated recently or you did some work on it, paying for the appraisal could be well worth it.

Qualifying for a HELOC

Of course, qualifying for a HELOC comes down to more than the appraisal. You must also prove you can afford the payment. The HELOC takes second lien position. This means if you stop making your mortgage payments (first and second), the HELOC lender might not get paid. The first mortgage lender has priority over any funds made during the sale of the home. There usually is not enough in the sale to cover the first and second loan.

Because of this higher risk, you should have good qualifying factors when applying for a HELOC. There isn’t one specific HELOC program lenders use. They each have their own. This means you may find lenders that require credit scores over 700 yet other that accept scores in the low 600s.

Generally, you should try to have the following:

  • A good credit score (680-700+)
  • Low debt ratio (your total monthly debts shouldn’t exceed 43% of your gross monthly income)
  • Stable job
  • Stable income
  • Assets on hand

Just like any other loan, you’ll need to shop around to find the best deal. Some lenders like HELOC loans and give favorable terms, yet other lenders don’t like the risk involved. If they do offer them, they are often for much higher rates and fees than others charge.

Make sure you pay close attention to the term as well. HELOCs often have shorter terms. Make sure you ask about the draw period and repayment period. These are two different periods in a HELOC. In most cases, during the draw period, you can use the funds over and over again. As you pay them off, you can use the funds again. However, you are only obliged to pay the interest on the funds you borrow.

During the repayment period, you make interest and principal payments on the amount outstanding. In many cases, you pay this over a 20-year period.

Every lender differs in what they offer. Make sure you ask detailed questions about the HELOC as well as if you need an appraisal. This can help you determine if the loan is worth it and what it will cost in the end.

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