We own Land and a home, wanting to downsize and just buy a home and lot. We do not owe anything on our land and home, but have asked about a loan using our land and home as collateral, but, even though our land and home are paid, the bank says they will only loan up to 80 percent of appraisal amount. Why is that when our home and land would stand good for the loan?
To supplement existing answers: the appraised value does not necessarily represent the net amount the bank could actually recover with a foreclosure.
Let's look at it from the point of view of the bank. Suppose the property appraises at $200,000 and they do what you want: loan you $200,000 with the property as collateral. Now suppose a short time later, you quit paying the mortgage and they have to foreclose. Can the bank get their $200,000 back?
An appraisal is only an estimate; nobody can predict perfectly how much a property will sell for. Maybe the appraiser missed something significant, and the property will only fetch $180,000.
Even if the appraisal was accurate when it was made, property values may have dropped in the meantime. Maybe a sudden economic crisis is driving real estate prices down across the board. Maybe interest rates have spiked. Maybe the county has changed the zoning regulations to locate a toxic waste dump next door to the property. In any of these cases, the property may again fetch well under $200,000.
Maybe the condition of the property has changed. Perhaps you trashed the place and it will take $30,000 to clean it up. (People have a tendency to do things like that when they get foreclosed.)
If the bank wants to get full market value for the property, they will incur the usual costs of selling a property: paying a real estate agent's commission, painting, renting furniture to stage the property, and so on. This will eat into the net amount they actually get from the sale.
It may take some time (perhaps months) for a property to sell at its full market value. During this time, the bank is out $200,000. That's money they would rather be loaning out at interest to someone else, so this represents lost income.
Foreclosing a mortgage is a fairly complicated procedure. The bank has to pay its staff, including lawyers, for a significant number of hours to get the foreclosure done. There will be court filing fees and so on. If you refuse to leave, they may have to get the sheriff to evict you; that has a fee as well. If you fight the foreclosure, that racks up even more legal fees. This too eats into the net proceeds from the sale.
So if the bank loans you the full $200,000, they stand a pretty significant risk of not getting all of it back, after expenses. You can understand that risk may not be worth the interest they would get from you on the extra $40,000.
On the other hand, if they loan you only 80% of the property's appraised value ($160,000), they effectively shift that risk onto you. Should you default on the loan, and they foreclose, all they have to do is sell the property for $160,000 or a little bit more. That shouldn't be too hard, even if it is not freshly painted or a bit trashed. They probably don't need to hire a real estate agent: just hold a quick auction, maybe first calling up a few investors who might be interested in flipping it. If it happens to sell for more than the outstanding principal of the loan, plus the bank's costs, then they will pay you the difference; but they have no incentive to make that happen, and every incentive to just get it sold quick. So any difference between the property's true value and the actual sale price now represents a loss to you first, not to the bank.
So you can see why the bank would rather not loan you the full value of the property. 80% is a somewhat arbitrary figure but it cuts their risk by a lot.
If you get a loan for 80% of the value of your house, that's equivalent to buying a house with a 20% down payment (assuming the appraised value is what you'd buy it for). That's the minimum down payment for Fannie Mae backed loans without PMI (mortgage insurance). See this table for more details.
Freddie Mac (the other major mortgage backer) has a good fact sheet on cash out loans (which is what this is called) here. It also specifies:
Maximum LTV ratio of 80 percent for 1-unit primary residences
As noted in other answers, the 80% rule is to protect the bank (and ultimately, Fannie Mae and Freddie Mac, who will eventually buy most of these loans) so it is more likely to recoup the total value of the mortgage if they must foreclose on the house.
Banks and lenders have become a bit more conservative since the housing crisis. 80% is a typical limit. The reason is to minimize the lender's risk if declining property values would put the borrower upside-down on the loan.
The banks figure that they'll get 80% of the value of the property at a sheriff's sale. So, they're lending you what they think they can recover if you default.
I am going to add just one more item to what are some very well thought out answers.
The element of "Cash Out"
If you are taking out 80% of the value of the home that you already own free and clear the bank considers this a "Cash Out" transaction - meaning you would effectively walk away from closing with a check for 80% of your home's value.
So in a hypothetical situation you have a $200,000 home value - you would be handed a check for $160,000 with which you could do anything that you wanted.
Granted, you are likely going to do something responsible with it and purchase another home - BUT (big BUT) the bank can't control what you do with it and that is the part they don't like - and therefore they treat these types of transactions with a higher degree of scrutiny.
It is all about control - if the property you are downsizing to fits their rules for lending they may actually loan you a higher loan to value on that purchase than they would on your "cash out" refinance transaction on your current home. With the purchase loan the money you get goes immediately to the purchase of a new home. In the "cash out" transaction it goes to a check with which you could do anything you want . . . and then not pay the loan back . . .
I know no one here would do that - but there are some folks that would . . . and this is one of the reasons "Cash Out" loans are not nearly as easy as they once were to get.
Imagine the bank loaning 100% of the sum of money you needed to buy a house, if the valuation of the house decreases to 90% of the original price after 3 months, would it be unfair for them to ask them for 10% of the original price from you immediately?
I suppose the rationale for loaning 80% is so that you will fork our 20% first, and so your property is protected from fluctuations in the market, that they do not need to collect additional money from you as your housing valuation rarely drops below 80% of the original price. Banks do need to make money too, as they run as a business.
protected by Community♦ Feb 7 '17 at 12:04
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