Appraisers are worried about a proposal to loosen appraisal requirements for some home sales. It will cut into their business if that happens, but they say it’s not about money. They are more concerned about risks to the lending environment, if homes are not accurately assessed. Without an appraisal, home buyers may pay too much for a home, or lenders may come up short if there’s a default.
Federal regulators want to raise the minimum requirement for an appraisal from $250,000 to $400,000. That covers more than two-thirds of the homes sold in the U.S., according to the Wall Street Journal. (1) But, the appraisal exemption would only apply to loans that not guaranteed by a government agency, like Fannie and Freddie. The paper reported, if the proposed rules had been in effect last year, appraisals would not have been required for an additional 214,000 homes worth about $68 billion dollars.
Replacing Appraisals with Valuations
Federal regulators acknowledge the value of the appraisal for residential real estate sales. They say in the proposal, “Appraisals can provide protection to consumers by helping to ensure that the estimated value of the property supports the purchase price and the mortgage amount.” But, they apparently don’t feel that licensed appraisers are absolutely necessary.
Instead of appraisals, they want lending institutions to get property evaluations that are “consistent with safe and sound banking practices.” What might that include? According to the proposal, “An evaluation should contain sufficient information and analysis to support the decision to engage in the transaction, although it may be less structured than an appraisal.”
Appraisal by Bot, or Drive By
So, lending institutions would still be required to get property evaluations, but they wouldn’t have to be done by licensed appraisers, and potentially not even by humans. We’re seeing this transition already with the use of artificial intelligence, machine learning, and algorithms. This technology is becoming more sophisticated, and many people in the real estate industry already use it for assessing home values. Or, they might use another method commonly known as a “broker price opinion” or “drive by.”
These so-called BPOs haven’t been allowed for traditional mortgages, so far, but there’s no such ban for their use by institutional investors with large portfolios. The Wall Street Journal says, sometimes they are the result of financial institutions who want to close deals quickly, without waiting for appraisals. But, according to Donald Epley, a retired professor who helped write the national appraisal standards after the savings-and-loan collapse in the 1980s, that method is “dumbing down the standards to make the loan.” The Journal says that in some cases, these drive-bys are “outsourced to India, where companies charge real-estate agents a few dollars to come up with U.S. home values by consulting Google Earth and real-estate websites.”
The current trend is headed toward the “automated valuation.” Real estate listing sites like Zillow already offer tools to estimate the value of your home. Zillow’s “Zestimate” has been controversial because Zillow posts the estimated value on listing pages, and sellers don’t always agree with it. It’s not clear whether the Zestimate and similar tools would satisfy these new looser standards.
These “looser standards” are what critics are concerned about. They worry that the appraisal exemption will open the floodgates to cheaper, computer-driven valuations and less-competent opinions that are not accurate enough to protect buyers or lenders.
The Wall Street Journal points out the Dodd Frank Act requires the adoption of quality control standards for automated valuations, but that that hasn’t happened yet. The CEO of a company that does automated valuations, called Appraisal Inc., told the Journal that his field is the “wild, wild west” right now. He says, “That just invites abuse of all kinds.”
HousingWire says, the Appraisal Institute is deeply concerned that the proposed rules could recreate the kind of poor underwriting conditions that contributed to the housing crisis ten years ago. The Institute’s president, James Murrett, said of the proposal, “The Appraisal Institute anticipates that that will result in a return to the loan production-driven environment seen during the lead-up to the financial crisis, where appraisal and risk management were thrust aside to make more – not better – loans.” He feels the FDIC learned nothing from past mistakes. (2)
Valuations Are Cheaper, Faster
The alleged motive for changing the rules is to cut down on transaction costs and to appraisal delays that could jeopardize a sale. Many of those delays have been the result of a critical appraiser shortage that can make it difficult to get an appraisal within tight deadlines.
According to the Wall Street Journal, the number of appraiser credentials has dropped about 80% in the last ten years. That’s apparently caused more problems in rural areas, where there are fewer appraisers to make the rounds. The problem was reportedly so bad in one part of Tennessee, a bank asked regulators to waive the appraisal requirement. That request was denied, but inspired a debate over the issue.
Critics say, the cost of an appraisal isn’t a big enough expense to change the rules. Getting a single-family home appraised can set you back from about $400 to $900, typically. Valuations would cost much less, but are the savings worth the risk? Appraisers go inside homes. Computers, and drive-by evaluators don’t.
But appraisers don’t always get it right either. The Wall Street Journal just did a big story on the Federal Housing Administration’s reverse mortgage program, and how much money it will lose because of inflated appraisals. (3) According to the FHA, losses will top $14 billion over the next several years.
The problem was discovered by the agency’s new director, Brian Montgomery. He wanted to know why the agency’s mortgage insurance fund was losing so much money, so he asked staffers for a review. They looked through about 134,000 reverse mortgages and found that at least 37% were overvalued by 3% or more. That gap is what the FHA pays the lender, when the house is eventually sold to pay off the reverse mortgage loans.
Why are those appraisals inflated? The Department of Housing and Urban Development did a study on this in 2017. As part of its conclusion, it says, “Appraisers seeking future business have little incentive in jeopardizing a loan closing by underestimating the collateral value.”
Former director of the FHA’S office home valuation, Gerald Kifer, told the Journal, “If you’re the one who can select the appraiser, who are you going to select? You’re going to select the guy who always hits the mark for you. That’s human nature.”
So there’s a little wild, wild west in the appraisal world as well.
(3) Inflated Appraisals: Wall Street Journal