A home equity loan allows a home owner to borrow against the value of the real estate. The lender actually decides on the amount of money to loan based on the value, so it must determine the value of the property. The tool the bank uses to determine the value, however, is an appraisal rather than an assessment. The latter is used by county or city tax collectors for property tax purposes.
Appraisals vs. Assessments
Appraisals and assessments both determine the value of a property, only in different contexts. Banks and mortgage lenders hire certified appraisers to physically examine a home to determine its fair market value — that which a buyer in the open market would be willing to pay. The appraiser considers many factors, including the age, size and type of home. Additionally, the building materials and any updates or remodels are factored in. Property tax authorities use the assessed value to determine the property tax bill. Generally, an assessment is based on the value of other homes in the same area, sales data or -- possibly -- a drive-by review of the property. Values are regularly reassessed in accordance with a set schedule.
Home Equity Loans
Values of homes typically increase over time. As you pay down the balance on your mortgage loan, you begin to build equity. The equity value of your home is simply the fair market value minus the unpaid loan balance. For example, if your property has an appraised value of $250,000 and you have an unpaid loan balance of $175,000 the equity value is equal to $75,000. A home equity loans is made against the equity value.
Regardless of how much equity you've built over time, a bank isn't just going to give you a home equity loan. You need to go through the application and approval process. Although the home equity loan is different than a traditional mortgage, the approval requirements are pretty similar. An applicant should have a good credit score and a good history of payments on the current mortgage loan, and will need to supply income verification in the form of pay stubs or tax returns. Additionally, the lender will most likely require an appraisal of the property.
There's a chance that the appraised value of your property will be lower than you anticipate or believe to be accurate. A low appraisal can hinder the approval of your home equity loan application. Various factors -- such as a declining real estate market -- may lead to a low appraisal. If you don't agree with the appraisal, the lender might be willing to accept a second appraisal, but remember that you pay for the appraisals. If this doesn't work, you might not be able to secure a home equity loan until housing values in your area increase or you eliminate more of the unpaid balance.
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