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One of the great things about mortgages is that if you don’t like your current one, you have the option to refinance and get a new one.
As a homeowner, you’d probably refinance for one of these reasons:
- Lower interest rates: If mortgage rates are low, you may be able to refinance and get a better interest rate.
- Avoiding mortgage insurance: If you’re paying for mortgage insurance, refinancing can help you get rid of it.
- Consolidating debt: If you have debt from credit cards or personal loans, you may be able to use your home to pay off that high-interest debt at a lower interest rate.
- Pay off mortgage faster: If you want to shorten the length of your mortgage, you can refinance to a shorter term and reduce the interest you pay. By a lot!
The refinancing process is pretty much the same process you went through to get your home mortgage.
You apply and the lender offers terms based on your goals, credit score and debt-to-income (DTI) ratio. While lenders usually prefer a DTI of 36% or lower, they may be willing to consider a DTI as high as 50%.
Just like that first mortgage process, one of the final steps is the home appraisal, which confirms the value of your home. Once that’s done, you’re good to go!
But what if the appraisal value comes in lower than what you expected?
Why a Low Appraisal Matters
When you bought your house, your lender probably ordered a home appraisal to make sure that you wouldn’t pay too much and get stuck with a home you couldn’t afford.
A refinance appraisal does the same thing.
Once the home appraisal provides a home value, the lender uses it to generate a key number called the loan-to-value (LTV) ratio.
LTV = The amount you want to borrow (refinance) / The appraised value of your home
Lenders use the LTV to make sure you aren’t borrowing more than you can afford.
Let’s say you owe $200,000 on your mortgage balance, and you want to refinance. If your home is valued at $260,000, your LTV would be 77%.
But what if the appraised value is less than what you expected? What if it’s $250,000 (putting your LTV at 80%)? What if it’s $240,000 (putting your LTV at 83%)?
80% or lower is ideal because it means you have enough equity, and you won’t need mortgage insurance.
Here’s how your LTV could affect your ability to refinance:
- Lower than 80%: You should be able to avoid paying for mortgage insurance.
- 80% or higher: You may still be able to refinance, but you’ll have to pay for mortgage insurance.
- 97% or higher: If the appraisal value is less than what you still owe on the mortgage, your loan may be considered “underwater,” and the lender may not be willing to refinance.
Why Your Appraisal May Be Low
If your appraisal came in lower than you expected, it’s normal to feel disappointed and frustrated. But before you start calling your lender or hitting send on angry emails to the appraiser, take a moment. Ask yourself what legitimate reasons may have led to this unwanted outcome.
What sources did you use to determine your original home value estimate?
Make sure you source professional pricing resources to get a realistic assessment of your home’s value. Home value estimates found on real estate websites may not always reflect accurate data and may be inflated to drive traffic.
Is it a buyer’s market or a seller’s market?
The greater the demand, the higher the home prices. If your neighborhood has properties for sale, but few buyers, it may be a sign that the area is going through a downturn and prices may fall.
Is your home in good condition?
Even if everything is structurally sound, cosmetic damage, an unkempt yard and even a messy interior can count against your appraisal value.
Are there comparable properties?
Comparable properties (often referred to as “comps”) are homes in your area used to determine home value. For example, if you have a three-story home, the appraiser will want to compare your home against other three-story homes, even if there aren’t many in your neighborhood.
Appraise the Appraisal
If your appraisal is low and you don’t know why, the first thing to do is not panic. While home appraisers are professionals, they aren’t perfect.
This is especially true if there are a limited number of professional appraisers in an area, and they’re pressed for time because of increased demand.
In fact, a study by Fannie Mae found that home appraisals come in below value around 8% of the time. And that number has been increasing in recent years.
Read the report
After the appraisal, request a copy of the appraisal report and read it carefully.
Did the appraiser:
- Describe the method that was used to assess your home value?
- Perform an in-person or drive-by inspection, or was it all done using online research?
- Correctly estimate the square footage and include the garage and other non-living spaces?
- Base their appraisal on comparable properties?
- Count the correct number of bedrooms and bathrooms?
- List all the amenities, including fireplaces, patios and pools?
- Include any home repairs and renovations, like a new roof or renovated kitchen?
- Mention energy-saving improvements, like new appliances or solar panels?
If you feel the appraiser missed something important, contact them to let them know. Document everything – but don’t forget to be polite.
Get a second opinion
If the appraiser is unwilling to adjust the price based on your feedback, you still have options.
Your lender selected the appraiser, but that doesn’t mean they’re the only option. Talk to your lender about ordering a second appraisal. Just remember that you’ll need to pay another appraisal fee.
Your Options When the Appraisal Is Low
Let’s say that everyone agrees that the appraisal is accurate. In some cases, the lender may simply decide not to move forward with the refinance.
It’s frustrating, but it’s not the end of the world. Keep making your mortgage payments. Look for ways to improve the value of your home. And hope that the real estate market starts working in your favor soon.
If the lender agrees to continue with the refinance, there are ways to make the best of the situation.
Pay the mortgage insurance
If you’re refinancing to get a lower interest rate or to take cash out of your home, it may be a good idea to take the refinance and continue to pay your private mortgage insurance (PMI).
If you’re saving money on interest, try paying more toward the principal each month. When you reach 20% equity, you can ask the lender to cancel the mortgage insurance.
If you’re close to 80% LTV, you can take advantage of a cash-in refinance. This is different from a cash-out refinance. With a cash-out refinance, you borrow against the value of your home. With a cash-in refinance, you make an upfront payment to get you over the 80% LTV hump. A cash-in refinance may cost more in the short term, but it could save you big in mortgage insurance and interest expenses in the long run.
Look for a relief program
If your home’s low appraisal value means you can’t refinance with a conventional mortgage, you may still have options.
There are currently two programs available that are designed to help homeowners with high loan-to-value ratios who want to refinance:
- Fannie Mae’s High LTV Refinance
- Freddie Mac’s Enhanced Relief Refinance®
These refinance programs are offered through normal lenders, like banks and home loan lenders. To qualify, your home must have been:
- Bought within the last 3 – 4 years
- Financed or refinanced at least 15 months ago
When they appraise low, you go high
Don’t be afraid to make the case for your home’s value – just be sure to do it respectfully.
If you find that you can’t move the needle, don’t stress. There are ways to survive a low appraisal and get what you need from a less-than-favorable refinance. But this much is true: You will be ready the next time you try.
Fannie Mae™. “Credit Risk of GSE Loans.” Retrieved October 2021 from https://www.aei.org/wp-content/uploads/2017/08/Fout-Panel-VI.pdf