APPRAISALS . . . SOME BASICS
In the past, we often relied upon the "willing buyer, willing
seller" concept to establish value. Given today's circumstances, lenders
rely upon appraisals to know that there is sufficient value to support their loan
amount. This is particularly critical on high LTV loans where there is little
equity for protection. Thus, even when a buyer is willing to
"pay a seller's price", the appraisal may not justify the requested
loan amount. The loan amount a borrower can acquire is determined by the
purchase price or the appraised value whichever is lower .
Sellers, thus, need to know that they are placing their property on the market
at a reasonable and saleable price, and buyers want reassurance that they are
purchasing at market value . (Lenders are required to
provide a copy of the appraisal to the borrower .)
There are times when the appraised value is lower than the purchase price but
because of a low LTV, the lender will still make the loan. In a higher LTV
transaction, even if a buyer, in spite of the low appraisal, wishes to proceed
with the purchase, there may be insufficient cash to do so. [i.e., Sales Price
= $200,000; Appraised Value =$190,000; Original anticipated loan = $180,000
(90% LTV); Lower loan amount based on appraised value now = $171,000;
Therefore, the Buyer is required to make up the $9,000 difference in cash to
continue the purchase.]
When preparing to sell a property, it is a good idea to secure a Comparative
Market Analysis (CMA) to assist in determining the appropriate sales price. A
comparative market analysis, by identifying recent "similar" sales
(known as "comps"), assists in setting the probable value at which
the property can be expected to sell. Comps can also be helpful when
encouraging a buyer to "make their best offer" when contemplating a
purchase.
An appraiser uses "comparable sales" ("comps") to
support his/her opinion of value for a specific property. Here is what a good
comp represents: A comparison of a recent (not more than 6 months ago)
"closed sale" of a similar type home in the same neighborhood (not
adjoining developments or across town). "Similar" means in style,
construction, size and age (typically not more than 3 years older or newer than
the subject). Any comp that does not meet the above criteria must be
"adjusted" for any differences.
Pending sales in escrow, while noted, are given little weight. Instead,
"closed" home sales are more important in determining the anticipated
value. Appraisers must now also note the "list price" for any homes
for sale in the same neighborhood. This could have an impact upon your sale if
there is a present listing at a much reduced price from recent sales. The
appraiser will be required to comment on whether values are declining (which remains
an issue for many lenders) or whether the particular low priced offering is
unique due to poor condition, a distress sale, etc. It is imperative that good
comps are acquired to support today's listing and/or sales price from the very beginning
of the transaction. It must be recognized that a recent sale of a 1 or 2 year
old home will not support a sale of a 10 year old home without a value
adjustment being made.
Sellers, eager to acquire top dollar, can be disappointed if the appraised
value is less than desired. When an appraisal comes in lower than the sales
price, the first instinct is often to blame the appraiser. In the past, appraisers
were sometimes asked to "push up the numbers" or "meet the sales
price". (Appraiser complaints that
they were being coerced by real estate licensees and mortgage originators
regarding home value appraisals, resulted in the adoption of a new process
called Home Valuation of Code of Conduct (HVCC) explained below.) While an
appraiser wanted to accommodate all persons in the transaction, if s/he succumbed
to the temptation to "make it work", there was the risk of an
appraisal review being done by the lender. While appraisal reviews used to be
infrequent, lenders began to perform reviews on a more routine basis. This
meant that after the loan file was submitted to the lender with the
accompanying appraisal, there was often an "in house" appraiser who
reviewed the adjustments made and the final reconciliation figures. If any
"red flags" appeared, a more complete review might be required.
Obviously, this impacted an appraiser’s ability and/or willingness to
"push the value up" very far. S/he had be
accurate the first time to avoid a possible reduction in value by the lender
prior to funding a loan.
Appraising today can be difficult. But, by understanding the restraints
placed upon the appraiser (by lenders) in determining value, hopefully, we will
not be so quick to blame the appraiser for a low appraisal. A Realtor can
assist a seller in determining the anticipated selling price of any property.
By acquiring sufficient information ahead of time, a seller can avoid confusion,
controversy and disappointment when setting the selling price for their home or
other property.
Appraisals and the New HVCC
Rules
The appraisal process
for conventional financing was, for many years, less complicated than that for
FHA or DVA loans. May 2009 that process was severely impacted with the adoption
of the Home Valuation Code of Conduct (HVCC). Lenders (including mortgage
brokers and other loan originators) were no longer able to order an appraisal
from a selected local appraiser. Instead, a system of Appraisal Management
Companies (AMC’s) was established from which appraisals assignments would
occur.
The motivation for the
plan was to establish regulations to “enhance the quality and
independence of the appraisal process”. In other words, to
“protect” the appraiser from coercive interference from lenders or
real estate licensees, who were thought to have contributed to an invalid
valuation process by “running up” home values during the heyday of
sub prime lending.
Critics immediately
countered that the new process was a way to deflect attention away from the
fact that the agencies did not provide sufficient oversight in the housing
debacle. Plus, critics indicated that local appraisers did not create the
market but were most often caught in a spiral in which they were
“chasing” home values as property kept selling for ever increasing
amounts. Ironically, the fraudulent case that spawned this
“regulation” was conducted via an appraisal management company, the
very same entity that is now proposed to protect consumers from appraisal
fraud.
The concerns of a united
real estate mortgage community that the new rules would impact how local
appraisers, mortgage lenders and realtors did business began to manifest
themselves immediately as the new process was initiated. But worse still were
the perceived negative impacts for the borrower/consumer. The increase in the
cost of appraisals, while most noticeable, was the least of the impacts. More
critical was that a lender had to be identified immediately in order to
initiate the appraisal process. Previously, the borrower’s application
and documentation could be acquired along with the appraisal before selecting a
lender. This allowed the loan originator to search for the best loan option,
avoid guideline changes that could affect the borrower and “discuss” any
concerns with an appraiser before incurring a cost for an appraisal that might
prove ineffective.
Lenders were also
affected. Additional costs were incurred as they had to establish procedures
and commit staff to monitoring the process and developing quality controls with
the AMC’s. Most costly was devoting time to working out appraisal errors
and valuation problems through a convoluted process that did not allow for
direct contact with the appraiser. Complaints about errors, inappropriate
comparison properties, inaccurately identified additions (requiring
non-existent building permits) and just plain bad appraisals mounted,
especially during the first months of the new process. The mortgage originators
had little access to the appraisal in order to identify valuation
irregularities. Acquiring an appraisal copy only after it had been completed
and delivered to the lender coupled with the prohibition to contact the
appraiser directly eliminated any timely or easy way to correct problems.
As feared, many local
appraisers, who best knew the market, were taken out of the process. It seemed to many that assigned appraisers were not only often new
and/or inexperienced but seemed to be super conservative in their valuations.
Complaints of receiving under-valued appraisals, compromising home sales,
seemed numerous. Because the AMC’s represented a third party that must be
paid, appraisers received less money per appraisal. The result in some
situations was a reduction of service (e.g., acquiring building permits when required).
Advocates of the new process indicated that the complaints are exaggerated.
Whether accurate or not, the “perception” that something was very
wrong can and did often replace reality. The process was likely neither as bad
as its critics suggested nor did it perform as well as
its advocates anticipated.
What
many loan originators, lenders and appraisers believe is that appraisers were
made the scapegoats, suggesting that they were responsible for the skyrocketing
home value spiral when it was the un-regulated “easy” credit with
its lack of any buyer qualification that spawned the sub-prime debacle. Whether
the HVCC process will reduce the perceived fraud within the valuation procedure
is problematic, given the fact that the fraudulent case that spawned this
“regulation” was conducted via an appraisal management company, the
very same entity that is now proposed to protect consumers from appraisal
fraud. We do know that the timeliness of the appraisal process has been
expanded, the potential for errors seems to have increased and any local loan
originator expertise and assistance in guiding their borrowers’ appraisal
experience has disappeared.
The success of continuing efforts to revise and/or eliminate
the HVCC process are yet to be known but new legislation has been adopted, some
of the key provisions are identified below. The italics are the author’s
comments.
The Wall Street Reform and Consumer Protection Act required
the appraisal process to be completely reviewed while retaining the core
purpose of the HVCC which was to assure appraisal independence. Any new rules
were to encompass a complete study of appraisal methods and would supplant the
HVCC set to sunset November 1, 2010. While coercive action will still be
prohibited, the good news is that the new rules addressed appraisal portability
and allow originators to ask appraisers to:
- Consider more
property information, including additional comparable properties;
- Provide details or
explanations for the value conclusion; and
- Correct errors in the
appraisal report.
While we will have to see how the new rules are ultimately
interpreted and enacted, in response to the numerous complaints about the HVCC
process, some potential changes include:
- A
second appraisal/field review can be requested. An appraiser may be asked
for a detailed explanation regarding the comps used and why. If a second
appraisal is ordered, the first appraisal will become null and void,
regardless of the value of the new appraisal, higher or lower. (it is unclear how such a request will
be made and exercised)
- Lenders
will not be required to order appraisals via an AMC. (While this sounds great, we do not yet know how the alternative
will be enacted. Lenders may still opt to use AMC’s? While some
believe this is a first step to allowing mortgage brokers the opportunity
to again order their own appraisals. The language says “lenders”
and this most likely means that we will see little change.)
- There
is language within the act that indicates that appraisers “should be
compensated in line with what is reasonable within their community”.
(When the AMC process developed,
appraisal fees increased but the appraiser’s actual fee declined.
The result was that many appraisers chose not to participate in the AMC ‘s as they chose not to work for the lesser
fee. Some appraisers have interpreted this new language as meaning that
they will again receive the greater portion of any fee charged and will
encourage these absent appraisers to again become available for appraisal
orders).
- Interior
photos are now mandatory, including kitchens, all baths and main living
areas. Photos of any physical deterioration, remodeling or renovation
projects are required. (We
don’t know how much scrutiny will be applied to worn out carpeting,
small damages to door frames, small holes in walls, deteriorating paint or
the myriad other now considered minor items. Will cluttered or
“messy” homes become problematic? Unfortunately, if lenders do
become too picky, it will encourage a new skill for “hiding”
such potential problems with furniture placement, hanging pictures or
camera angles).
- The
value of personal property included in the sale will now be deducted from
the value. (Does this mean that if
the agreement
calls for the “refrigerator to remain”,
“window coverings are included”, the “chandelier is to
remain” or the “in
wall TV is to stay” will result in deductions?)
6. Portability of Appraisals . . . whereas
in the past appraisals were done prior to loan submission to a specific lender,
the borrower could easily access another lender source in the event of complications
or a loan denial with the original lender.
The new process eliminated this portability and requires the borrower to obtain
a new appraisal (with additional cost) if the loan is to be re-submitted to
another lender. The new legislation allows for lenders to share the original
appraisal. (The new rules also address
liability in any “assignment” of an appraisal and currently lenders
are reluctant to accept any appraisal that they did not originate via their own
AMC process. Thus, true appraisal portability remains unlikely regardless of
the negative affect for consumers).
Change is inevitable and we will all make the necessary
adjustments. The key is to determine exactly what is required by the new
legislation and how we must accommodate the changes. We will keep you informed
as we learn the details.
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