Will a low appraisal wreck your refi?

The 30-year fixed mortgage rate keeps getting lower and lower, making it a great time to refinance your mortgage and cut your monthly payment. But as Pat Esswein, associate editor of Kiplinger’s Personal Finance magazine, reports, homeowners have to clear a few hurdles before they can refinance.

One of those hurdles is the appraisal, which determines the value the bank will assign to your home.

That’s an important number because it determines your refinancing options and affects your monthly payment and interest rate. For example, if your home value drops and your loan-to-value is higher than your lender allows, typically 80 percent, you have to either increase your equity with cash or pay for mortgage insurance.

I recently spoke with Esswein about ways to get the highest possible value before the appraisal, and what to do if your appraisal comes in low.

What to do before an appraisal to get a higher home value

There are a few things you can do to get highest possible appraisal possible.

First, consider researching the appraisal company. “This may be a little bit of a stretch, but when looking for a lender, ask what appraisal management company they order appraisals from,” says Esswein.

What you want is an experienced appraiser who really knows your local market, and you’re most likely to find that kind of appraiser at “a smaller, local appraisal management company that probably pays more and therefore attracts the best appraisers,” says Esswein. “Some companies go for the cheapest hires who also are willing to travel really far, so that means they’re inexperienced and they don’t know your area very well.”

Second, get your home in shape. “Make your house show well,” says Esswein. “Clean, declutter and fix things that need to be fixed so that when the appraiser comes, they’ll note that your house is in the best condition it can be.”

While you’re at it, create a house file for the appraiser that documents any upgrades or recent repairs, such as the new roof you installed two years ago. “When the appraiser actually comes to your home, have the file ready for them and walk around with them to point out the upgrades,” says Esswein.

Third, research recent comparable home sales. “Even though you may feel that prices are rising in your market, and in many markets they have, the appraiser still has to find comparable recent sales to support the value,” says Esswein. “One recent comp doesn’t make a trend, and appraisers may be adjusting prices more slowly than you wish.”

Instead of hoping the appraiser will pull a complete list of comps, Esswein suggests contacting a real estate agent to ask for a list of recent comparable sales, which you can add to your house file. “An experienced real estate agent will know what’s most comparable to your house,” she says.

What to do if your appraisal is low

So what happens if your appraisal is lower than expected? Is it possible to get another appraisal from a different company?

Esswein says you could shell out $250-$350 for a second opinion, then appeal to your loan officer with the new appraisal. “But before you do that, you should ask your loan officer if they’ll even consider the second appraisal,” says Esswein.

It’s more likely that the first appraisal will stick, but you still have options for refinancing.

Let’s say your home is appraised for $180,000. You still owe $162,000 on the mortgage, which is 90 percent of the value of the home. What are your options?

When it comes to maximum allowable loan-to-value, 80 percent is usually the magic number, so there are three things you can do if you aren’t at 80 percent.

Option one: Bring more cash to closing. If you can afford to put in an additional $18,000 in cash, you’d reduce the loan balance to 80 percent of the value of your home.

“Keep in mind that even if you anted up that money, you still have to have enough money in your reserves to satisfy any lender requirements for adequate savings, which is usually two months’ worth of mortgage payments, but can be more,” says Esswein.

Option two: Refinance into an FHA loan. An FHA loan is a Federal Housing Administration-backed mortgage loan.

Although an FHA loan requires just 3.5 percent equity, “with recent increases in FHA’s upfront mortgage insurance and monthly premiums, private mortgage insurance (PMI) could be cheaper,” says Esswein. Which brings us to…

Option three: Pay for PMI. PMI protects the lender if you stop making payments. “Because home values have fallen, many homeowners who didn’t need PMI when they bought their home will need it when they refinance,” says Esswein.

If you opt to refinance and need PMI, there are two ways you can pay for it.

One way is to simply pay for PMI yourself, which typically costs 0.5 percent to 1.5 percent of your loan amount per year. “Your lender will add the cost of PMI into your monthly mortgage payment,” says Esswein. “You would continue to have to pay the extra premium each month until you have 20 percent equity, at which point you can contact the lender and ask them to cancel PMI. Otherwise, when loan-to-value reaches 78 percent, they have to drop PMI automatically.”

The other way you can pay for PMI is lender-paid mortgage insurance. With lender-paid mortgage insurance, the cost of PMI is folded into your interest rate. The less equity you have, the higher your rate. “The higher rate applies for as long as you have the loan, so this option makes sense only if you don’t plan to own your home for the long term,” says Esswein. “You’re going to have to pay the higher rate for as long as you have that loan, it’s not going to fall away when you reach 20 percent equity.”

Before you decide to take lender-paid mortgage insurance, Esswein says to calculate your monthly payments and the total interest you’ll pay over the life of the loan, based how long you plan to keep loan.

So if you have to take on PMI, is it worth it to refinance? After all, you’re trying to lower your payments, not add extra fees!

Esswein says that as long as you’re saving money, it’s worth it. “PMI is a tool you can use if you need it, and if you’re still reducing payments and saving on interest, then it makes sense,” says Esswein.

And even if you have enough cash to bring your loan-to-value to 80 percent, you might think twice about spending it. “Before you bring cash to the table, decide what else you might want to spend that cash on,” says Esswein. “Don’t drain your emergency fund to avoid PMI.”

Finally, if your appraisal is so low that you owe more on the house than you could sell it for, you have options, too. Esswein recommends makinghomeaffordable.gov, which highlights home loan programs and refinance options for people who are underwater on their homes.

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This article is about House and Home