What Did the Appraisers Do Wrong?

Early in November, the New York state Attorney General Andrew Cuomo accused home appraisal company eAppraiseIt of yielding to pressures from lenders like Washington Mutual and appraising the home values too high. According to the news report, Mr. Cuomo said

“consumers are harmed because they are misled as to the value of their homes, increasing the risk of foreclosure and hindering their ability to make sound economic decisions.”

This sounds a little odd to me. Perhaps you can help me figure out how an allegedly inflated appraisal hurt the consumers.

If I understand correctly, here’s the sequence of the events related to a home purchase:

(1) The seller lists a home for sale. The buyer looks at it.
(2) The buyer likes it and makes an offer to buy the home.
(3) The buyer and the seller haggle. They finally agree on a price and terms. They sign a sales contract. The buyer gives the seller 3% of the contract price as “earnest money.”
(4) The buyer applies for a mortgage with the sales contract attached.
(5) The lender hires an appraiser.
(6) The lender approves the mortgage application.
(7) The buyer accepts the mortgage by signing the mortgage papers.

The purchase price is negotiated between the buyer and the seller in step (3). The buyer comes up with a value of the home they are buying before an appraiser is involved. In a mortgage refinance, the process starts with step (4). The appraiser is called in after the fact by the lender. The lender wants an appraisal to see if the risk is acceptable if it lends the money. The appraiser works for the lender. If the appraisal comes in too low, the buyer will have to look for another lender. Every loan has an application form. If the lender approved a loan which was more than the home’s value, it’s because the buyer applied for that much. I just don’t see how the appraiser hurt the buyer. There was a willing buyer and a willing seller. They struck a deal. Our public officials should stop blaming everybody else when the deal didn’t benefit one party as much as they wanted.

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Comments

  1. Chuck Fouts says

    The appraisals are a symptom of a larger problem. Deregulation helped create the SIV and CDO instruments we hear about so much in the news lately. Those instruments allowed loan originators to take mortgages and sell them off. This ended the loan originators responsibility to originate good loans. Moodys and other rating agencies exacerbated the problem by rating the SIV and CDOs that were sold off with ratings that did not match reality. How does the appraisal fit in to this? In order to get the loan approved for a subprime borrower an appraiser was sought out that was willing to appraise the house for well beyond what the purchase price happened to be. The consumer was possibly hurt by being approved for a loan that they could not afford.

  2. Anonymous says

    I am friends with an appraiser. He has told me that buyers and lenders do put pressure on him to appraise homes at the sales price to get the deal to go through. In a hot market with a bank that can send a lot of work your way, there may be a conflict.

    You could say that if an appraiser does over value something upon request that is a lack of integrity. On the other hand both of the other parties are asking for this and then blaming the appraiser. Not surprising. Its always somebody else’s fault.

    Ted

  3. Julie Rains says

    An appraiser is involved in a mortgage deal to provide independent review of the home’s worth; the appraisal process is integral to (what should have been) checks and balances of the mortgage system. The value of the home is not just what the buyer is willing to pay but should be based on a market analysis, construction quality, features, age of the home, etc.

    If a buyer is getting a mortgage loan, then the transaction is not just between the buyer and seller. The lender is now involved, and if the mortgage is securitized, then the company who buys the securitization is involved, and if the company is publicly held, then investor who invests in the company who buys the securitization is now involved.

    If you hired a home inspector to make sure the home was within code and there was no major structural damage or hidden repair items, then you would expect the home inspector to give an unbiased report on the condition of the home, not a report that favors one party (the seller in this case).

    Are inspections and appraisals done in the right order? Maybe not, but they still should be performed independently and without bias.

  4. Staci Carsten says

    This is really tricky. A lot of the problem begins with mortgage brokers, who are not concerned about the lender (and often even the borrower, unfortunately). Lenders do approve appraisers, and expect them to ensure that they are not loaning too much money on a particular property.

    At the same time, appraisers don’t want to be known as “the guy/gal who always brings the value in low, making a pain in the butt for the loan officer, the realtors and the buyers and sellers.” So they do try their best to justify the sales price as it is.

    They want to make a law here that says on a refinance we can’t tell the appraiser what we or the borrower expect the property to be worth. Which is unfortunate, because we (MOST of us anyway) don’t do that in order to commit fraud, but in order to ask the appraiser if we’re in the ballpark, so that if he figures out we’re not, he can let us know BEFORE we spend the borrower’s $400 only to tell them we can’t do a loan for them.

    It’s a big mess. If everyone would just conduct business ethically, life would be a lot simpler.

  5. Anonymous says

    “If the appraisal comes in too low, the buyer will have to look for another lender.” Yipes-actually if the appraisal comes in “too low” that means that probably the financing should not take place. It is unethical to shop loan companies/appraisers to make the deal work.

    The house is collateral for the bank in case the borrower defaults on the loan. If the borrower pays cash for the home, he can pay any price he wants but since the bank is financing the loan, they have a right to make sure there is enough equity in the home in case the borrower defaults and the home has to be sold to pay off the loan.

    Inflated appraisals are only one part of the problem but they are a significant problem.

  6. TFB says

    Thank you for all the great comments.

    Chuck, I disagree with your last statement:

    “The consumer was possibly hurt by being approved for a loan that they could not afford.”

    Whether the buyer is able to afford the loan is very subjective. The lender is in no position to know that. Some people can afford to use 60% of their income on loan repayment, while some others can afford only 10%. If the buyer doesn’t even know whether they can afford it, the lender won’t know either. Plus, the buyer asked for the loan amount. They applied for that amount. The lender merely gave what the buyer wanted. How could they hurt the buyer by giving them what they wanted?

    Ted, I agree with what your friend is saying. It’s really lame to place the blame on the appraisers while all parties involved in the transaction want the deal to go through.

    Julie, I agree that an appraisal should be objective. An inflated appraisal hurt the mortgage backed security purchaser if the loan package was represented with an artificially low loan-to-value ratio. I just didn’t think the home buyer can blame the appraiser though.

    Finally, anonymous, I don’t think it’s unethical to shop for a mortgage lender who will approve the loan application. The lenders are sophisticated institutions. Some are more aggressive than others. As long as there is no fraudulent misrepresentation by the buyer, I think applying to a different lender after being declined by one is fair game. To borrow a tag line from Lending Tree — “When banks compete, you win.”

  7. Ernesto says

    My experience would add a few steps to your scenario:

    Loan originator finds client whose warm breath can fog a mirror.
    Realizing there’s no one in the world dumb enough to do 100% financing they find an appraiser willing to ‘hook them up’ at 125% of asking price securing them financing on a terrific ARM loan.
    Buyer sees appraisal numbers and thinking they’re getting a great deal so they follow through with purchase.
    Having ‘equity’ in the house they close, then quickly get a HELOC to tap into their ‘money’
    Fed raises rates causing their HELOC payments to go up.
    ARM resets now they can’t afford either payment.
    Is all this the appraiser’s fault? Not entirely, but like a three legged stool, without their support the whole structure would have collapsed. Loan originators and borrowers are expected to lie a little in this transaction to get the deal done. The appraisers play a key role since they’re expected to be unbiased hence they become the primary people who convince the loan underwriters to make the deal.

  8. TFB says

    Ernesto,

    What you described might have happened elsewhere but it was not the case in the WaMu and eAppraiseIt case. If you read the actual complaint filed with the court, there is no indication of WaMu shopping for buyers *before* a sales contract was signed or a loan application was made. WaMu merely approved the buyer’s application. They gave what the buyer wanted. If the real estate market didn’t turn south, I bet there would be none of this.

    Appraisal is subjective. A big part of the value is land. You may be able to put a value on the structure based on material, construction and depreciation, but when the market is moving fast, valuing the land is nearly impossible. Last month’s price quickly becomes obsolete. If you call in 2 appraisers, you will get 2 different values. Who’s to say which appraiser is right? Is the low value too conservative or is the high value inflated? Hard to say.

  9. Ernesto says

    TFB

    Thanks for the link to the complaint. Having read through it, I stand by my comments, I think what I say is very accurate in describing part of the ongoing foreclosure issue.
    I work in an industry (insurance) were one side of the buyer-seller arrangement is expected to have extensive knowledge of the industry and the other side is expected to purchase on faith; that if something goes wrong, then things will go in their favor.
    The mortgage debacle is largely the fault of people who put their faith in mortgage brokers, lending institutions and (finally) appraisers who arrange the mortgages. Is there an innocent party in this? Are we dealing with victims? No one is truly innocent, but an honest appraisal system may have avoided some of these poor loans.
    Let’s hop the way back machine to 2005. I had just finished rehabbing a duplex I intended to keep as a rental property. I wanted a fixed rate mortgage with cash out at closing, my mortgage guy said no problem, he’ll get his ‘best’ appraiser on it. The appraiser pulls comps from an adjoining upper income neighborhood, showing my property worth more than true market value, making my mortgage sail through loan underwriting with no PMI.
    WaMu does exactly this. They work with Realtors, mortgage brokers, mortgage wholesalers, the whole lot. If $116 Billion a year in loans get approved and sold to investors, WaMU gets paid, the brokers get paid the Realtors get paid, even the appraisers get paid. Everyone gets something, except when it goes wrong. Now of all the people in this transaction, which one has a responsibility under Federal statute to be honest and unbiased? The appraisers.

  10. Anonymous says

    The best possible solution to the problem is that when a house is to be sold, an appraisal is obtained by either the seller, who then sets the sales price at the appraised value. Lenders, at the behest of the potential buyer, could reimburse the seller through the potential loan proceeds for the cost of the appraisal. The seller merely orders the appraisal through some “appraisal portal”, perhaps the new Home Valuation Protection Institute. This way, no one has access to the appraiser, and no undue pressure or coercion can be exercised from anyone associated with the deal at any point. Someone has a problem with anything in the report, address it through appropriate channels with the HVPI, or another state or federal agency that is empowered to deal with it at that point. That solves everyone’s problem, including turn-time issues. No one is hurt, everyone is protected and happy.

  11. TFB says

    @anonymous – I like your idea. The appraisal should be done before the contract is signed although you have to convince all parties to accept the appraisal as objective. If a seller didn’t like the appraised value, will they be able to try again? I guess we can require a mandatory waiting period between appraisals.

  12. Anonymous says

    Thanks tfb. The idea here should really be determining what is truly the market value of the home with no ax to grind from any entity whatsoever. The market comes into play when the seller, or individual looking to refinance his/her home, has the appraisal sent (being kept in the IHVP (Institute for Home Value Protection) to the prospective buyer/broker/lender for their particular transaction and what is the best deal the seller/refinancer can receive from the prospective buyer/lender. This would include attempting at this point to have the cost of the appraisal rebated to them. To me, it seems pretty simple. Can anyone think of a problem with this scenario? How about you Chuck?

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