There was a time when a mortgage originator would order appraisals from a trusted appraiser with whom he had worked before. Appraisers would visit loan officers, drop off their cards, chat with loan officers in an effort to build their “book of business.”
When the mortgage meltdown began in late 2007 and gathered momentum through 2008, regulators and politicians took aim at the slowest-moving, least-represented group: the appraisers. THEY were to blame for The Troubles because they intentionally delivered their reports with outrageously high opinions of value. THEY should be reined in and regulated. Or so the regulators and politicians believed.
Thus was born the Home Valuation Code of Conduct (HVCC). It was folded into the sweeping Dodd-Frank law, becoming “Appraiser Independence.”
The effect of this rule is that, where once we were able to select a local, experienced appraiser whose work we trusted, now we must order those essential reports through a third party—an Appraisal Management Company (AMC). The AMC assigns an appraiser, collecting its fee in the process. The cost of appraisals has risen dramatically, while the fees actually paid to those doing the work has declined.
But that’s not what I want to talk about—as outrageous as that fact is. Because all licensed appraisers are now considered to be exactly equal, AMCs hand out assignments regardless of the appraiser’s experience, reputation or familiarity with the market. If they have a valid license, they get the assignment. As a result, we have seen a shocking incidence of low appraisals, often threatening to torpedo the transaction.
The appraisal process works like this: the appraiser describes the Subject Property (the home being appraised) in a standardized way (square footage, room count, lot size, amenities, etc.). Then he (or she) finds three or four similar properties close to the subject that have sold within the previous six months. He adjusts each of those “comps” to account for their differences from the Subject. A comp that is 200 square feet larger than the Subject would have its value reduced accordingly—around $85 per square foot in the East Bay, for example. The adjusted values of these comps are then averaged, with more weight being given to those properties that the appraiser decides are more suitable than the others. The end result is the appraiser’s Opinion of Value.
If the appraiser disregards one comp and chooses one that sold at a lower value, the final value of the Subject may be lower. If the appraiser fails to adjust for differences in condition, location, upgrades and the like, the final value may be lower. If the contract price is $300,000 but the appraiser says the value is $290,000, buyer and seller have a problem. The lender will base its loan amount on the appraised value.
Disputing the appraisal is invariably an exercise in futility; it is rare that appraisers can be induced to change their opinions of value, even with glaring errors.
There are four choices: walk away from the deal, get the seller to reduce the selling price, get a smaller loan (meaning more cash down) or pay mortgage insurance.
Mortgage insurance protects the lender where the loan to value ratio (LTV) is higher than 80%. In the case of our $300,000 home appraised at $290,000, the LTV based on the appraised value will be 83% if the buyer intends to put $60,000 down. The monthly MI premium will be $64.00. This is likely to be a short-term expense, as I have discussed in an earlier article.
The real estate market today is highly competitive; there is still a shortage of inventory, and properties often sell above their listed price with multiple offers. Sellers are less likely to reduce their selling price than they were before. Buyers (and their Realtors© have to look to every possible way to hold their transactions together. A low appraisal may be a bump in the road, but it is NOT the kiss of death for that transaction. Mortgage insurance may be the knight in shining armor to riding to the rescue.