Whether you need funds for a home improvement project or a low-interest loan for debt consolidation, borrowing against your home equity with a home equity line of credit (HELOC) can get you the financing you need. But before you can tap into your home equity, you first need to prove that you have enough of it.
An appraisal is a key part of that.
Because HELOCs and home equity loans are secured by your house, a lender will likely require an appraisal to determine the value of your home. An appraisal protects both the lender and the borrower by making sure you don’t borrow more than what your house is worth. Don’t worry, though — this appraisal might be a lot faster (and cheaper) than the one you got when you bought your home initially.
Here’s what you need to know about HELOC appraisals and when you need one.
Are Appraisals Required for Home Equity Lines of Credit (HELOCs) and Home Equity Loans?
Most lenders require an appraisal before approving you for a HELOC or home equity loan. This appraisal will confirm the current value of your home. After all, a lender needs to know how much your house is worth to calculate how much you can borrow.
Unlike the appraisal you need for a brand new mortgage, however, a HELOC or home equity loan appraisal is often completed in just a few seconds from a computer — no home visit required.
Your lender will likely run a quick, computerized appraisal on your home to assess its value before issuing you a HELOC. If the lender requires a full walk-through, there are steps you can take to maximize your home’s value.
How Does an Appraisal for a HELOC or Home Equity Loan Work?
When you take out a HELOC or home equity loan, you’re drawing on your home equity, or the difference between the amount you owe on your mortgage and what your home is worth. Home equity lenders, therefore, require an appraisal to determine the current value of your home.
This appraisal protects both the borrower and the lender. If you don’t pay back your loan and your home goes into foreclosure, a lender wants reassurance that it will recoup its losses. Along similar lines, you don’t want to borrow more than your home is worth, as an inflated loan could sink your finances if you need to move, experience a natural disaster, or have another emergency.
Different lenders have different appraisal requirements. Some lenders will cover the cost of the appraisal, whereas others will charge you upfront as part of the closing costs or roll the fee into the cost of your loan. Here are the different types of appraisal a lender might require for a HELOC or home equity loan:
Automated Valuation Model or Desktop Appraisal
The automated valuation model (AVM) is the fastest and cheapest method for a home appraisal. A lender uses a computer program to crunch the numbers on local property values, home sales data, neighborhood trends, and other residential real estate data to determine your home’s estimated market value.
“An AVM is where we just punch in the address and the computer, the AI spits it out,” explains Gerald Robinson, broker/owner at 1st Choice Mortgage Company. “It’s super easy to pull an AVM. It takes just 15 to 20 seconds.”
This computerized appraisal is fast, easy, and may only cost around $20.
A desktop appraisal is similar to an AVM. Unlike the computer-generated AVM, a desktop appraisal is performed by a human appraiser using property data from third-party sources, such as public records. Desktop appraisals also do not require an in-person home inspection.
Some lenders take a closer look at your property with a drive-by appraisal. This hybrid approach may still rely on AVM data, but an appraiser will also check out your home’s exterior.
“A drive-by appraisal is where I’m not going to bother you, but I’m going to at least drive by to make sure the property is there,” says Tim Nguyen, CEO & Co-Founder of BeSmartee, a fintech company in mortgage and commercial lending technology. “Give it a quick peek from the street and make sure that it hasn’t fallen down or anything.”
Drive-by appraisals will have a higher price tag than AVMs, typically costing between $100 and $150.
Finally, a lender might require a full walk-through appraisal, during which an appraiser inspects both the interior and exterior of your property.
“It’s pretty rare that you have to have a full-fledged appraisal,” says Robinson. However, he points out that a lender might be more likely to order a full appraisal for borrowers with a low credit score or weak credit history.
“Credit can influence whether or not a walk-through appraisal is ordered,” Robinson explains. “If you have a low FICO score, then the lender may want to really look at the collateral to ensure that it is decent collateral.”
A full appraisal requires hours of work and will be pricier than the AVM or drive-by methods. Typically, a walk-through appraisal costs around $350, but it could be more depending on your location, home type, and other factors.
Home Equity Rates Are on the Rise
The highest inflation in 40 years has yet to wane. The Consumer Price Index showed prices up 8.2% year-over-year in September, barely an improvement from August’s 8.3%.
That has implications for the Federal Reserve’s efforts to bring price growth down, but it also means a lot for consumers, especially those looking to borrow money. The Fed will likely continue to raise its benchmark interest rate – the federal funds rate – in its ongoing bid to stem demand and lower inflation. But that rate affects the cost to borrow money across the economy, particularly home equity lines of credit or HELOCs.
HELOCs often have variable interest rates that are directly tied to an index – the prime rate – that moves in lockstep with the federal funds rate. When the Fed raises rates, it means HELOC borrowers pay more.
Home equity loans with fixed rates aren’t as directly affected, but those rates are set based on the lender’s cost of funds, which also rises as rates go up.
The economic situation means home equity rates are likely nowhere near done rising, experts say. “I don’t expect [rates] to rise at the rate they have been over the last nine to 12 months. But I think they will go up,” Kevin Williams, a CFP and founder of Full Life Financial Planning, told us. “I’m hopeful that they’ll slow down, but we’ve seen a lot of up and down so it seems like there’s still room for them to rise.”
Homebuying vs. HELOC Appraisal
When you buy a home, lenders require a full walk-through appraisal before issuing your mortgage. This appraisal assesses the fair market value of the home and reassures the lender that the property is worth enough to guarantee the loan.
“If it’s a full appraisal, there’s no difference,” says Nguyen. “A full appraisal is a full appraisal, regardless of the purpose.”
Most lenders don’t require a full appraisal for a HELOC or home equity loan, however, but instead opt for the faster AVM or drive-by methods.
Are No-Appraisal HELOCs Worth It?
Although some lenders might advertise no-appraisal HELOCs, most will at least complete an AVM on your property. If you find a lender that’s willing to issue a HELOC or home equity loan without looking at this data, you might end up having to pay more for your loan.
“In banking and lending, it’s all about risk,” says Nguyen. “If someone is willing to lend money on a property where they don’t really know the value or the value is more uncertain, the interest rates and the fees you have to pay might be higher.”
Again, assessing the value of your home doesn’t just protect the lender. It can also protect you from over-borrowing, so it’s probably not wise to skip the appraisal step when applying for a HELOC.
How to Calculate Your Home’s Equity After Appraisal
While your appraisal reveals your home value, it doesn’t tell you how much equity you have. To calculate your equity, you need to subtract the outstanding balance on your mortgage from your home’s appraised value.
Appraised value – balance owed on your mortgage = equity
Let’s say that your home is valued at $500,000 and you owe $300,000 on your mortgage. Using this formula, you can see that you have $200,000 in equity.
Most lenders will let you borrow up to 85% of the value of your home, minus what you owe on your current mortgage and any other loans secured by your house. This is known as your loan-to-value ratio (LTV).
To calculate the amount you can borrow with a HELOC or home equity loan, you’ll need to multiply your home’s value by the lender’s allowed LTV, then subtract your mortgage balance and the balance of any other HELOCs or home equity loans on your house.
(Home value x CLTV) – mortgage balance = equity available for you to borrow
Using the same example, we can multiple 0.85 x $500,000 to get $425,000. By subtracting the $300,000 you owe on your mortgage, you can see that you have $125,000 in available equity.
Note that some lenders cap your LTV lower, whereas others will let you borrow up to 90% or more.
Thanks to a rapid rise in home values over the past year, homeowners hold a record amount of home equity. According to data provider Black Knight’s April 2022 Mortgage Monitor, the average homeowner holds $207,000 in tappable home equity, an increase of 34% over the past year. While experts don’t believe we’re in a bubble, you still might be wary about borrowing more money than you need just because you have the home equity. Otherwise, you may end up owing more on your loan than your house is worth — otherwise known as being underwater — if home values drop by the time you want to sell your house and you haven’t paid off your HELOC yet.
How to Maximize the Value of Your Home
While you can’t dictate the value of your home to an appraiser, you can take certain steps to make sure your appraisal accurately reflects your home’s market value. Here are a few steps that could help maximize the appraised value of your home.
Share a List of Recent Updates
“Make sure they have a list of all the recent improvements and things you’ve done,” advises Robinson. “More information is always good.”
If an appraiser isn’t doing a full walk-through, you can share this list with your lender and ask them to pass on the information.
Make Your Home Look Its Best
If a lender requires a drive-by or walk-through appraisal, make sure the interior and exterior of your house look their best.
“They’re going to take pictures and walk through the property, so present it like it’s going to be an open house,” says Nguyen. “Clean up and make sure it looks presentable.”
Besides cleaning, you might repaint a room or fix anything broken to present your home in the best possible light.
Collect Data on Local Comps
An appraiser considers data on local home sales when assessing the value of your home. You might collect some of this data yourself and share it to make sure the appraiser hasn’t missed anything. While there’s no guarantee the appraiser will include these comparable properties in their report, it’s worth a shot.
Answer Your Appraiser’s Questions
Finally, make sure that you’re available to answer any and all of an appraiser’s questions as they view your property.
“Make sure the property appraiser has access to the property, and you’re ready to answer questions,” says Nguyen. “That’s really the best thing you can do.”
Alternatives to Getting a HELOC
Many homebuyers opt for a HELOC because of its flexibility and relatively low interest rates compared to personal loans and credit cards. However, it’s worth considering these alternatives when deciding on the best borrowing method for you.
Home Equity Loan
Similar to a HELOC, a home equity loan lets you tap into 85% or so of your available home equity. But while a HELOC lets you draw on a credit line over time, a home equity loan works like an installment loan. You get a lump sum upfront, typically at a fixed interest rate, and pay it off in equal amounts over time.
While home equity loan rates tend to be higher than starting HELOC rates, the fact that home equity loan rates are fixed means that you don’t run the risk of your interest rate and monthly payment going up unexpectedly in the future. If you know exactly how much you need to borrow — and want to avoid the variable rate of a HELOC — a home equity loan could be the superior choice.
Cash-out refinancing is another option for homeowners who are looking to borrow money. With a cash-out refinance, you replace your existing mortgage with a new, larger mortgage and pocket the difference.
Keep in mind that since a cash-out refinance replaces your mortgage with a new one, you’ll pay the new interest rate on your entire mortgage amount, not just the amount you take out as cash. This is in contrast to home equity loans and HELOCs, which are commonly known as second mortgages because they don’t alter your primary mortgage.
A personal loan is another option, especially for strong-credit borrowers who can qualify for a competitive rate. Like a home equity loan, most personal loans fund a lump sum amount upfront and require you to pay it back with monthly payments over a set period of time.
In general, personal loans have higher interest rates than home equity loans and HELOCs because they’re unsecured debt and thus riskier for the lender. The minimum credit score required to get a personal loan varies by lender, but in general, the lowest rates are reserved for borrowers with good or excellent credit. However, many lenders let you check your rates with no impact on your credit score, so it could be worth prequalifying to see if you can get a personal loan with better rates and terms than a HELOC or home equity loan.
If you haven’t built up much equity in your home but you have good credit, you might be able to borrow more with a personal loan than you would with a home equity loan. However, if you have a lot of equity in your home, tapping into that equity is likely the best way to access larger loan amounts and longer loan terms.