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If New Appraisal Rules Stick, Big Changes For Borrowers, Mortgage Brokers & Even Sellers Come May 1st

January 8th, 2009 categories: Buying, Loans / Financing

If you’re planning to take out a conventional loan after May 1, be prepared for an entirely new playing field, as that’s when Freddie Mac & Fannie Mae’s controversial new Home Valuation Code of Conduct is scheduled to take effect.

The new guidelines will affect all conventional (”conforming”) loans and are designed to help ensure that property appraisals reflect the true value of the property. Pumped-up or highly suspect appraisals were a big part what caused the huge real estate mortgage debacle that we’re in right now.

An Objective Evaluation?

So this new policy is designed to shore up some of the problems that allowed appraisers to be heavily influenced by those who stood the most to gain by making sure the sale went through: mortgage brokers, real estate agents and borrowers/buyers.

Presently, mortgage brokers order the appraisal, typically from an appraiser with whom the mortgage broker has a long established working relationship. They often are told what minimum value is needed in order for the loan to go through, so the appraiser goes out to the property already knowing what number the person who hired him (the mortgage broker) is expecting.

A Flawed System

You can see how such a system is fraught with all sorts of opportunities for an appraiser to be influenced into making subjective evaluations that will support the value the mortgage broker is expecting.  The appraiser knows that he’ll stand a much better chance of getting future business from the mortgage broker lender if his appraisal comes in at the hoped-for value.

So there’s a natural tendency for many appraisers to do all they can to find comps that will support the value they’re shooting for and to overlook those comps which might result in a lower appraised value. If their appraisal meets the target price, then the mortgage broker’s happy, the borrower’s happy, and if it’s part of a real estate sale, the real estate agents and the seller are happy, too.

However, the big fly in the ointment, as you might imagine, is that the company lending the money — not the mortgage broker, but the actual lender — is blind to all that’s gone on behind the scenes. The loan package they receive includes an appraisal from a local certified appraiser showing that the home is clearly worth the amount necessary for the desired loan amount. They have no idea whether or not the appraiser performed an objective analysis of the property free from any outside influences.

Someone Else’s Money

So the person who’s actually lending the money is deciding whether this loan makes sense based entirely on documentation provided by and paid for by the mortgage broker, who isn’t putting up any of his own money and who only stands to make money if the lender approves the loan.

Most lenders now perform review appraisals, which is an opportunity for them to quickly double-check the comps and the valuation adjustments the appraiser made. But that’s not nearly as thorough as having a completely different appraiser, hired by the lender visit the property and perform a separate on-site full appraisal.

Removing The Mortgage Broker From The Equation

In a sense, that’s what the new Freddie/Fannie policy does, but in a slightly different manner. Instead of performing a second appraisal just to make sure the first one is legitimate, the new HVCC will simply take the selection of the appraiser out of the mortgage broker’s hands.

No longer will the appraiser be beholden to the mortgage broker for future business. The concept behind this new policy is that the lender (and ultimately Fannie or Freddie, when they buy the loan) will get a fully objective estimate of value free from outside influences by those who stand to profit.

Moreover, if the borrower or mortgage broker doesn’t like the appraisal and requests a second appraisal simply to hopefully arrive at a higher appraised value, sorry, no dice. A second appraisal can be ordered only if there appears to be major flaws or errors in the first one.

The Impact On Top-Of-The-Market Prices

Where this could ultimately have a huge impact is in those real estate transactions where the buyer and seller have agreed on a top-of-the-market price and where the whole deal is dependent on the appraiser validating the agreed-upon price.

Since the appraiser shouldn’t know the contract price, he or she presumably will not be tempted to wear the hero’s hat by pumping up the numbers in order to make the deal work. And the finished appraisal will reflect the true value of the property, regardless of what the seller wants or how much the buyer is willing to pay. And the lender, as well as Fannie & Freddie, will be able to better decide whether the loan really makes sense.

Right now, with property values still declining in many areas, the new regulations probably won’t pose an immediate threat to most real estate transactions. But once values turn the other way and start to climb, the new policy could end up thwarting many a deal.

Back when the market was at its hottest, it wasn’t all that unusual for a buyer in a multiple-offer situation to offer $30,000-$50,000 over the asking price. Almost always, the appraisal miraculously came in right at the negotiated price. Yes, it could have been coincidence in some cases. But I’m sure more than a few appraisers put on that hero’s hat and did their best to make the deal work.

Loan Declines Could Increase Once The Market Turns

So once the market turns and sellers start pushing their asking prices and buyers again start offering above the asking price again on a routine basis, we may see a much larger percentage of loan declines due to appraisal issues than ever before. And that would definitely affect buyers and sellers in a huge way.

Since many of the loans that went into default in recent years were on properties where the loan appraisal was clearly inflated, Fannie and Freddie obviously had to take steps now to prevent a similar debacle down the road.

And, in its purest sense, the purpose of the appraisal is to give the person lending the money verification that the value they’re relying on in making the loan is legitimate. So if the new HVCC does that, then it should bode well for the future health of the credit markets, which can only be a a good thing.

There’s always a possibility that the HVCC could be modified between now and May 1. Or it could be modified after its in practice for a period of time. But barring that, as it stands right now, May 1 could signal the end of business as usual, at least as we know it right now.

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This entry was posted on Thursday, January 8th, 2009 at 5:29 pm and is filed under Buying, Loans / Financing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

  1. Brent Mendelson said at April 7th, 2009 at 7:49 pm

    This will be a major disaster and only increase the decline of local real estate markets. We have problems with loan officer influence, everyone if they are honest knows that. This will hurt not help the borrowers as it’s intended. There are MAJOR loopholes in the code that will allow larger banks to kepe playing the game. Large banks will get to select the appraisal management companies they want to work with on a regular basis. What do you think will happen then when the value isn’t there. They will be talking to the appraisal management companies instead of the appraisers. Independent appraisers will soon be a thing of the past. Most of them don’t even get that yet. I know a few that have already given up because of the fee splits they have seen. They will be paid much much less for their work and be given more work to do. I wish someone would stop and THINK about what this means to the borrower. After May 1st my answer will be “give me $400 bucks, we will order it thru the lender and if the value is there then great and if not you just wasted $400″ If the value is in question I also will not be locking loans until after the appraisal is back because lenders will refuse your business if you burn too many locks. So the rate you could havehad will be bye bye sometimes because of this. It will slow things down, be more expensvie and and will definately lead to more loan rejections and a drop in property values. There is so much more with this idea. I wish someone could explain how the AG of NY could impose his grandstanding stupid ideas on the rest of the country but once again let the big banks off with business as usual. Has anyone actually READ the code and see all the loopholes? Thanks for letting me vent my frutration and anger.

  2. Rod Herman said at April 10th, 2009 at 7:52 am

    Thanks for reading Brent. As with any change in policy due to governmental intervention, most of the time they’re knee-jerk reactions to a larger problem. We all know that many loans that were made between 2003-2006 were given to borrowers who clearly couldn’t afford it.

    Many of these borrowers took on their mortgages based on a blind belief that the home’s value would quickly climb, providing them with instant wealth. History has proven that many of those who bought early came out okay. But most who bought a few years later, at the top of the market, lost everything.

    So enter the government. In an effort to fix everything, they came up with what they saw as easy solution — stop appraisers from inflating values to simply match what an emotionally driven borrower wanted to pay. Let the appraiser call it as he or she sees it without worrying about how that final number will affect their future workload from this lender.

    In theory, it all makes sense. And to be sure, this new policy, as it’s presently shaped, will prevent some ill-conceived loans from closing. But as with any across-the-board policy, it will also impact many innocent bystanders — lenders who do a reputable job and buyers/sellers who agree on a home’s legitimate market value only to be caught in the cross-hairs of some underpaid appraiser’s hurried evaluation that comes in $5,000 below its realistic market value.

    Send out 10 appraisers and I guarantee you’ll get 10 different values. If they know the local market, if they pull relevant comps and if they make legitimate adjustments when comparing these comps to the subject property, you’d expect the values from one appraiser to another to be relatively close.

    But bring in appraiser from 50 miles away, who’s vaguely familiar with the neighborhood he’s visiting and who has no real familiarity with that local market and there’s a good chance that the appraisal could come in radically lower (or higher) than its true market value.

    Appraising a piece of real estate is a very subjective process. No two homes are exactly alike, no two cities are exactly the same, and no two markets are exactly alike. So appraising is certainly not an exact science. In its truest form, it should be prepared by someone who knows the local market like the back of their hand and knows first-hand why a buyer might pay $10,000 more for a home on this street versus a home three blocks away.

    But with this new policy, we’re probably going to see those appraisers less and less. Instead, it will Mary from 50 miles away or Jim who needs a GPS system to find the best way to get to a city he’s only been in three or four times before. In other words, an appraisal environment that’s somewhat doomed from the outset.

    From what I’m hearing, for many big banks/direct lenders it will be ‘business as usual’ — they’ll still be able to hire their regular appraisers. The appraiser might now be selected by the bank’s corporate office from their “panel” of approved appraisers , but from what I understand, that panel will consist of appraisers hand-picked by the same loan officers who used to order the appraisals themselves, essentially ensuring that the same appraisers they’ve been using all along will continue to get their business.

    But for mortgage brokers, it will be a far different story. They’ll submit the loan and find out only after the appraisal is complete who did the work and how it came out.

    In the end, it very likely will signal a decline in business for mortgage brokers and an increase in business for direct lenders.

    If it ultimately limits competition by forcing mortgage brokers to close up their own shop and go to work for a direct lender, that wouldn’t be a good thing.

    Hopefully the government’s attempt to fix a system that definitely contributed to many of today’s mortgage defaults doesn’t go too far. Time will tell.

  3. Brent Mendelson said at April 17th, 2009 at 1:43 pm

    Rod, you nailed it in several different ways. I am most upset at banks “lenders” just basically doing business as usual and brokers such as myself are being forced to conform to a different set of rules. Just like YSP. As a broker I have no problem showing the client what we make on each loan. As a bank, well that doesn’t need to be done and no one can really explain/defend that practice. Once again the govenrnment doesn’t understand what it is doing and sided with big business against the little guy. I guess their lobbyists are better than ours. Bottom line is the consumer will soon be forced to accept a less competitive market place. Not sure how that will help them. Thanks,

  4. Clint Garner said at May 1st, 2009 at 4:35 pm

    Again, our elected officials believe this is the wild west where all bankers wear white hats and all brokers wear black hats.

    I have no problem showing my YSP. I’m not ashamed of my income and don’t hide anything from my clients. But there has never been one plausible explanation as to why bankers don’t need to disclose their YSP and brokers do. The same issue goes with this appraisal issue. I have no problem not ordering my own appraisal if that’s what the law requires and if it makes this business better for everyone. But if their reasoning is that brokers aren’t lending their own money, then I get to take exception.

    First, this should mean that unless the appraisal was completely independent and followed the same process as the broker, then that originating bank should NEVER be allowed to sell that loan–because if they sell it to another bank, wouldn’t their whole argument be invalidated? Wouldn’t the bank have a financial reason to want the value inflated? It should be funded and serviced by the same bank for the full term.

    And second, I beg to differ that as a broker I don’t have any money invested. Last I checked, as a tax payer, the banks’ money IS MY MONEY!

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