One of the most important steps to refinancing your home is to get an appraisal. An appraisal is a certified professional’s opinion of the value of a home based on factors such as number of rooms, location of the property, property size, and much more. The appraiser will spend about an hour examining the house, taking photos of the interior, exterior, amenities, and surrounding properties in order to arrive at their final decision of the home’s value.
Lenders require an appraisal when refinancing the home in order to ensure that they don’t lend more than the house is worth. For example, if the house later goes into foreclosure, the bank wants to ensure that they will be able to resell the property and make their money back. Once the appraisal is conducted, the bank will use that value, along with the borrower’s income, assets, and credit history to determine how much it will lend them.
Factors That Influence Interest Rates
Lending out mortgage loans is a risk for banks, so they tend to go the extra mile to make sure the borrower is capable of paying the loan back in full. Because the banks are taking a risk every time they issue a mortgage loan, they’ll have interest rates that they require the borrower to pay back as well. So, depending on a variety of factors, the interest rates will vary.
One factor that will easily determine an interest rate is the borrower’s credit score. Essentially, the higher a borrower’s credit score is, the better rate they’ll receive. A credit score above 740 will generally receive the best rates from lenders, but those with a credit score of 620 or above will be applicable to receive good rates as well.
The property type, such as a single family home, apartment, or townhouse, has an affect on the interest rates as well. Typically, if you’re refinancing an apartment or condo, you’ll receive higher interest rates opposed to refinancing a single family home.
In analyzing how much risk the lender will actually be taking by issuing a mortgage, banks will often use a loan-to-value ratio. This ratio, defined as mortgage amount divided by appraised value of the property, will give the lenders a look at the details of the loan and will assist in determining the amount to lend, along with interest rates to include.
Typically, high LTV ratios are seen as higher risk, and therefore will produce a greater interest rate if the mortgage is accepted. If the LTV ratio is 75% or lower, the borrower will begin to see a decrease in interest rates, because the lender is taking less of a risk by issuing the mortgage. If the value of the home increases after the borrower receives a fixed loan, they can refinance in order to receive improved interest rates. In addition, their LTV will go down as the value of their home goes up.
If the appraisal value was lower than expected when refinancing, the fixed rate will increase because the LTV will be higher. If an LTV reaches above 80%, a borrower is required to get private mortgage insurance, which protects lenders against a loss if the borrower defaults. The need to get private mortgage insurance is based on the value of the home at the appraisal along with the amount that the borrower places as a down payment.
Avoiding Faulty Appraisals
The biggest consumer complaint throughout the mortgage process is when they receive a bad appraisal. An appraisal may be inaccurate if the appraiser is unfamiliar with the area, as a huge portion of the appraisal decision is based off of the area surrounding the property, and the value of surrounding homes. If an appraiser is unfamiliar with the location, chances are they will make less educated estimates about the value of the property.
Another way to make sure that an appraisal is correct is by making sure that the appraiser reports directly to the lender. Many lenders hire an appraisal management company (AMC) to handle all appraisals. Because the appraisal management company hires the individual appraiser, the appraiser reports back to the management company instead of the lender, meaning there is less accountability in ensuring the accuracy of an appraisal.
Ensuring Accurate Appraisals
Majority of the appraisal is dependent upon the sales of recent homes in the area. However, a large part of the review depends on features consistent within the property being evaluated. An appraiser will take their time to consider as many factors as possible, including:
- Exterior and interior condition
- Total room count
- Condition and age of home’s systems
- Exterior amenities (garage, decks, porches)
- Kitchen and bath improvements
- Unappealing features
It may seem like the fate of mortgage loans and interest rates are out of the hands of the borrower, but luckily there are some things that a homeowner can do to their home before an appraisal that will improve the chances of getting a better review. First and foremost, homeowners should make sure the house is spotless. Any extra “junk” laying around is an eyesore and should be thrown away. Also, make sure any home improvements are completed by the time of the appraisal so they don’t look like unfinished projects and so you get the added value of the upgrades.
In order to ensure an accurate appraisal, the homeowner should make sure the home is looking in tip-top shape. This way, the borrower will receive an accurate appraisal, leading to a fair LTV rate, which in turn leads to a reasonable interest rate for the refinance loan.