Out of all the cacophony caused by the current meltdown of this country's financial industry, one of the sources in the grass roots mechanics of how all this housing mess came about has been largely ignored: The appraisal.
In the past, until a few years ago, FHA maintained a list of approved appraisers who were given assignments by FHA, not the lender. While there is no sure thing, this system made it more likely that the appraiser would be impartial, that she or he would be an advocate for the property – not the lender, the buyer or seller, or even the realtor, if one was a participant. This system allowed the appraiser to maintain an arm's length relationship with others involved in the transaction.
Under pressure from the banking/lending industry, plus the efforts in Washington to downsize government, FHA abandoned that system in favor of allowing each lender to choose its own appraiser. While HUD still requires that those performing appraisals for FHA-insured mortgage loans be approved via application and testing, the arm's length situation that formerly prevailed is no more.
Also, until a few years ago many banks and other mortgage lenders employed one or more staff appraisers, who valued properties being secured by that institution for conventional or insured conventional loans. A few lenders still maintain appraisers on staff, but the obvious appearance of a possible conflict of interest finally made the maintenance of them untenable for most lenders. On the surface, this seemed to be a good thing – not for staff appraisers of course, but for the lending industry as a whole – in that it would promulgate that arm's length relationship.
That, however, has not been the case. Pretty much across the board, lenders maintain a list of approved appraisers who are not employees, but who are, in effect, fee paid contractors. The same pressures remain; in order to remain on that approved list, each appraiser must play ball, as it were.
Of course, it has become more complicated than that. Three major factors have developed over the past 15 to 20 years:
First, the advent of so called "mortgage brokers." By and large, over time, these people became the real bottom feeders. Most of their clientele were people who could not obtain approval from any of the more mainstream lenders. If purchasing a home, many of these wannabe mortgagors came into the game often with little cash, questionable income, spotty employment records and weak credit scores. If refinancing existing loans, many brought to the table some or all of the above, plus the added problem of attempting to borrow against a property having little or no equity. More often than not, these were the people on behalf of whom mortgage brokers were attempting to obtain approval. Note that a mortgage broker makes nothing unless the loan is closed.
Herein lay the problem for the appraiser. Especially with refinances and home equity type loans, the pressure came loud and clear from brokers that a certain figure must be met in the appraisal for the deal to work. Failure to comply meant that the broker would simply make a phone call or two until he or she found an appraiser who would get the value up where it needed to be.
Second: The advent of computer generated Automated Valuation Models, or AVMs.
AVMs are created via large data bases maintained by companies which gather real estate sales data, much like locally maintained multiple listing services (MLS), but on a regional or national level. These AVMs use this accumulated data to determine the value of individual properties via computer generated models. Many lenders have adopted their use in lieu of standard appraisals. In some instances, an AVM valuation may be backed up by a so called "desk top" or "drive by" appraisal performed by either appraisers or real estate brokers. Neither the desk top nor the drive by report involves an actual "feet on the ground inspection of the property.
AVMs tend to work best where there is an ample amount of data – say for a 1200 square foot, three bedroom, two bath, brick veneer ranch home built on a crawl with a 2 car attached garage located in a subdivision of hundreds of other 1200 square foot, three bedroom, 2 bath, brick ranches having large numbers of recent sales. However, their dependability wanes dramatically in areas where there is less homogeneity. Also, the data compiled by these AVMs is often spotty at best; and at times, wholly inaccurate – far less complete and accurate than data typically found in traditional MLS data systems.
The appraisal has long been considered by lenders, realtors, and even sellers and buyers, as a fly in the ointment. An appraisal that fails to meet the sales price or whatever the minimum value estimate necessary to attain the prescribed loan-to-value ratio is, will kill the deal. Lenders have done everything possible to remove the appraisal – and consequently the appraiser – from the equation. The excuse usually raised is the cost factor. This argument is bogus in that the cost of the average appraisal in today's market is somewhere between $275 and $350, or so. (The cost for larger, more complex properties may be higher, but such properties are generally outside the norm.) That cost pales when measured against the average total costs of closing a mortgage loan. The real reason is control. The lender generally has less control over an independent appraiser. A bad or low appraisal, as noted, will either kill a deal outright, or at best, cause a delay while another appraisal is sought, in the hope that the first appraiser, perhaps with a little nudging, will "see the light."
The marriage between computer geeks and the lending industry has brought about the development and use of AVMs in the effort to obviate the need for on-the-ground appraisals. However, as noted, these models are often based on inaccurate data. It is also much easier for anyone generating these reports to selectively piece together data which supports whatever value the lender is seeking, owing to less oversight. Keep in mind that in these instances, no one ever so much as lays eyes on the property in question. By comparison, a full blown Fannie Mae appraisal is a fairly detailed and painstakingly developed report, often consisting of 20 to 30 pages (sometimes more), which must meet a number of specific guidelines set forth by Fannie or Freddie and/or HUD and/or the VA. Detailed explanations must be included in the event any aspect of the report does not follow the aforementioned guidelines.
Third: The emergence of appraisal management companies (AMCs). These are generally regional or national companies which act as a sort of clearing house or middle man for lenders to obtain appraisals and in some instances various aspects of loan processing, including credit checks, verification of borrower information, title work/insurance and even closings. In their middleman capacity, AMCs take requests for these services and then assign them to appraisers, title companies, etc., who have applied to and been approved by the AMCs.
As little as most appraisers like it – because this necessitates fee sharing – this arrangement does once again create an arm's length situation between the lender and the appraiser. At this juncture, I am not sure just what percentage of current residential mortgage appraisals are being handled through AMCs, but the number has been steadily rising over the past two decades or so.
As with the S&L debacle in the early 90s, there are certainly some appraisers who have been culpable in creating the current financial mess by succumbing to pressures and inflating values. On paper a skilled appraiser can make pretty much any property appear to be worth whatever figure a lender or broker stipulates.
In defense of appraisers though, it is a tough, competitive industry for them, just like most everything else. An appraiser's livelihood usually depends wholly on the favor of loan originators or loan processors, AMCs and, yes, mortgage brokers. Their loyalty to appraisers only goes as deep as the success of recent loans. "What have you done for us lately?" Happily, most appraisers operate above those pressures, but it is precarious at best. Appraisers have to eat like everybody else.
While I certainly don't contend that what is happening in Washington even as I type, is solely or even primarily due to bad appraisals, bad appraisers, or even to the evil mortgage brokers and AVMs, nevertheless, they are and have been players in all this. A return to more traditional lending and valuation procedures could go a long way toward a more equitable and transparent lending process.