How Is Equity Determined When Refinancing a Second Mortgage?

Many lenders use electronic appraisals for second mortgage refinance loans.
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Young homeowners can use a low cost second mortgage such as an equity line of credit to pay for the installation of a new kitchen, to consolidate bills or even to pop for a dream vacation. However, many of these products have variable interest rates, and you could possibly lower your payments by refinancing into a new fixed-rate second home loan. If you want to increase the size of your line or loan, you can do so but only if you actually have equity in your house. Lenders use a couple of methods to determine the value of your home and the equity you own in the property.

Automated Valuation Models

Many banks waive the closing costs on second mortgages, but loan underwriters do not like to waste money, so steps are taken to reduce the costs that banks must absorb. Automated valuation models offer banks a low-cost way to determine the value of your home and the equity you have in it. These valuations are based on an electronic analysis of recent sales of similar homes in your market. AVMs do not take into account upgrades such as granite counter tops and energy efficient appliances. These reports also don't reflect your home's defects such as damaged ceilings or faulty wiring. Having received the appraisal, the bank deducts the current balance of your first mortgage plus the payoff you owe on your second home loan. Your equity represents the money you have left after deducting these two balances.

Full Appraisal

If you do not like what the AVM report has to say about your nest's market value you can contest the valuation. In such instances, the lender will order a full appraisal that typically costs several hundred dollars and involves a licensed appraiser touring your home. The appraiser will take into account all of the upgrades and defects. Some appraisers base the value of homes on the cost of replacement which means the amount it would cost to rebuild your home from scratch. Others base valuations on recent comparable sales. Either way, the lender deducts your first and second mortgages from the appraised value to determine your level of equity.

Loan To Value

If you have received the appraisal and it suggests that you have some room to maneuver, you might still have to contend with your lender's loan-to-value restrictions. Many lenders cap first mortgages at 80 percent of your home's value while second mortgages are capped by a combined loan-to-value that includes both your loans. Some lenders allow you to borrow up to 100 percent of the property value between the two loans. Other more conservative lenders limit loan amounts so that you cannot cash in all of your equity. This gives lenders some breathing room to cover legal fees if your loan goes into foreclosure.


If your appraisal values your home at $200,000, and your existing loan debt amounts to $150,000, that would mean you have $50,000 equity in your home. Your lender bases the loan decision on these amounts, but the loan closing does not always represent the end of the story. In declining markets where home prices are falling, lenders often order AVMs for previously financed properties. A lender can legally reduce an existing line of credit if your home drops in value. However, lender's can only reduce your access to the unused portion of an equity line. A lender cannot require you to payoff an existing balance on an installment loan or line of credit just because your equity vanishes because of market conditions.

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