There is a simple reason why an assessment is such a crucial part of the process.

If you are applying for a mortgage to buy a home or to refinance your current home loan, chances are your mortgage lender will ask you to do an appraisal before approving you for the loan.

An evaluation is carried out by a professional. The appraiser comes to your home, assesses its condition and compares your property to those recently sold in the area, making adjustments for the various features. The appraiser then provides an estimate of the home’s fair market value.

Appraisals cost money and can sometimes derail your ability to get a loan approved, but they are an important part of the mortgage approval process. Here’s why.

There’s a Simple Reason Mortgage Lenders Require an Appraisal

Mortgage lenders require an appraisal before giving you a loan because they need to make sure the home is worth enough to secure the loan and that the lender won’t lose money if you don’t pay the bills. Let’s see how it works.

Houses are collateral for mortgages

Your home serves as collateral when you take out a mortgage and the lender has a property interest in the property. If you don’t pay the mortgage bills as promised, the lender has one asset to sell: the house.

Since the home guarantees the loan, mortgages are secured loans, which is why the rates are lower than many other types of debt. The risk of loss is lower for lenders. But, to make sure that the house acts as sufficient collateral, lenders set a maximum loan-to-value ratio. This is the limit on the amount of money they are willing to lend you at a certain percentage of the value of your home.

For example, if you want the best and most competitive rate, the loan will need to be 80% or less of the value of the house in the open market. So, for a house of $ 250,000, the lender would be willing to lend you up to $ 200,000.

An appraisal determines the loan-to-value ratio

Many lenders will give loans with a loan-to-value ratio above 80%. In fact, some will allow you to borrow up to 97% of the home’s value. If you go for a loan-to-value ratio greater than 80%, you will usually have to pay additional fees for mortgage default insurance. Mortgage insurance provides protection for the lender if they have to foreclose.

However, to calculate the loan-to-value ratio, lenders need to know the real market value of the home. And that may be less than what you are willing to pay for the house. The appraiser does an appraisal to get the most accurate picture of the home’s current value so the lender can make sure they’re not lending too much money for a home.

If the appraiser determines that the house is worth less than what you pay, the lender may require you to deposit more money or may not be willing to give you the loan. Otherwise, the lender may not be able to sell the house for an amount sufficient to get back all the money they loaned you for the house.

Unfortunately, this means that if your valuation is lower than expected, it could cause you problems in the home buying process. If this happens, you can try to appeal your assessment. But if that fails, you may need to bring in more money to buy or refinance your current mortgage.

Appraisals are crucial for lender protection

Once you understand the role of an appraiser, it’s easy to see why lenders require appraisals. While this can be an additional burden to overcome, it is also good for you to make sure that a property is actually worth what you are paying for it before you proceed with the sale. Don’t be disappointed to find that an appraisal is required when buying a home, as it is a crucial part of the mortgage approval process.