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A home equity line of credit (HELOC) offers a flexible way to borrow money, but due to the large transaction and high stakes—after all, your home is on the line—the process is far more complex than applying for a personal loan or credit card.
Before approving your HELOC application, a lender typically requests an appraisal so they can have an accurate value for the home and ensure you have enough equity to safely borrow against it.
Why Would an Appraisal Be Needed for a HELOC?
In order to initially qualify you for a HELOC, lenders will review your credit, income, repayment history and other criteria. If you're approved, the HELOC amount you can get approved for depends on a few factors:
- How much you have left on your mortgage. Lenders usually require you to have at least 15% to 20% equity before you can borrow against it.
- The value of your home. When applying for a HELOC, lenders often typically allow borrowing between 60% and 85% of the home's current appraised value, minus whatever is left on your mortgage balance. The actual dollar amount can depend significantly depending on the home's value.
- Your creditworthiness. Your financial history, debt-to-income ratio (DTI) and ability to repay can influence not just whether you're approved, but how large your line of credit will be.
Because the home's value plays a critical part in determining how much you can borrow against it in the form of a HELOC, lenders often require an appraisal to ensure they're working with the correct numbers. If your appraisal finds your property has jumped in value in recent years, that means you have more equity (and can borrow more).
If your appraisal unearths issues such as poor maintenance, or drastic depreciation in the local market since you bought, the appraisal value may come in low. If that happens, the lender can deny a HELOC application or limit the amount you can borrow if you don't have much equity.
Another potential pitfall with HELOCS is if you get approved now, but your home's value decreases significantly in the future. In that situation, since a lower value means less equity in the home, a HELOC lender may reduce your existing credit line accordingly. This can unexpectedly lower your borrowing power. Additionally, if your equity becomes negative—meaning the value of the house is less than what you owe on it—the lender may freeze your HELOC. These situations aren't common, but it's important to be aware of the possibilities.
How Does the Appraisal Process Work?
The appraisal process can have some variation depending on your lender. Their goal is to determine the market value of the home, and seeing how the home has been maintained or improved (or not) helps provide an accurate number. If a home is in disrepair or has outdated appliances and systems, it'll have less value than a clean, updated home that's more appealing to buyers.
An independent appraiser studies your house, along with local market data, to create the appraisal (the current value). The lender then uses the appraised amount, along with the other factors mentioned earlier, to determine the size of your line of credit. Appraisal fees typically cost around $300 to $400, according to Consumer Reports.
Prior to the pandemic, it was common for lenders to require a full appraisal, which entails an appraiser viewing the property in person and physically inspecting it. To minimize contact during the pandemic, however, appraisers began using other techniques that were less invasive. This included "desktop appraisals," which are done without a home visit; instead, appraisers do it from the office by compiling records and analyzing data. Some appraisers also began using drive-by appraisals, which allowed them to view the exterior of the property without going inside the home.
As the pandemic has lessened in severity, some lenders are once again conducting full, in-person appraisals, while others are still allowing the more flexible options. Sometimes, the borrower can request a certain type of appraisal.
Bear in mind that appraisals done via desktop or drive-by miss out on seeing the interior of your home. If you've spent a pretty penny to renovate your kitchen, the appraiser won't see it, and you may not benefit from the boost in value.
Likewise, if the home is not in great condition, they won't see it either, and you may get cleared to borrow more than you should. You can advise them of this information. Without a full inspection, you'll run the risk of an inaccurate valuation, which can create issues down the road.
Alternatives to a HELOC
HELOCs typically have lower interest rates than unsecured forms of borrowing, but they do put your home at risk, and the upfront fees—including those for an appraisal—can be costly. Home equity loans come with some of the same downsides.
If you don't want to spend so much on financing, or you don't think an appraisal will go your way, here are some other alternatives to consider:
- Credit card: A HELOC and a credit card are both revolving forms of credit, meaning you can borrow again from the credit line as you pay it off, and you only borrow what you use. A credit card likely won't let you borrow as much money, and interest rates are usually higher than HELOCs. But if you need to borrow smaller amounts repeatedly, and especially if you can qualify for an introductory 0% APR offer, a credit card could be a solid alternative. Plus, your home won't be on the line.
- Cash-out refinance: When you have a HELOC or home equity loan, you have that plus your mortgage loan. Another option to tap your equity is a cash-out refi, in which you replace your current mortgage loan with a larger one, then pocket the difference. It has some similar upfront fees and requirements, including a possible appraisal, but it leaves you with just one loan rather than two. Some borrowers may find this more manageable.
- Personal loan: Personal loans don't require as many fees or requirements as HELOCs. While interest rates for unsecured loans may be higher, those with excellent credit can typically nab reasonable rates. Personal loans lack the flexibility of HELOCs, since the money can't be reborrowed, but they do usually feature fixed interest rates with predictable monthly installments (unlike HELOCs, which can have variable rates).
Get Your Credit HELOC-Ready
Even if your home is likely to ace an appraisal, you may not get approved for a HELOC—or qualify for the terms you want—if your credit needs improvement. Before applying for a HELOC, consider checking your credit for free on Experian. You'll see where you stand and get tips on making improvements. When put into practice, your credit score can rise, and ultimately, boost your chances of getting approved for financial accounts and landing the best terms.