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The Importance of Independent Appraisals
Pressure by lenders to “hit the numbers” has been the subject of much discussion in the appraisal industry for years. But, finally, after the introduction of H.R. 1295 into congress, the issue of the pressure put on appraisers by lenders has been brought to the forefront of national attention.
To more fully understand today’s situation, lets turn the page back to the Savings and Loan Crisis of twenty-five years ago.
In an attempt to acquire higher bank earnings, the early 1980s saw a new breed of aggressive lender in the banking market, the “commission loan originator.” At this time, bank management began connecting lender compensation to the quantity, not the quality, of loans contracted.
Also at this time, S&Ls entered the commercial lending arena as a consequence of federal legislation. Hungry for profit and attempting to break into a mature market, S&Ls primarily pursued borrowers who had been rejected by other lenders. Unfortunately, the S&Ls did not have the knowledge to jump in to such a competitive market and often relied on the advice from other industry 'experts', advice that often proved unsound. In addition, the fail-safe separation of power structure between loan originators, lenders, regulators and appraisers disintegrated. And as a consequence, billions of dollars of bad loans were made.
The result of this collapse in the system was 1989’s Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), an act that served to bail out the S&L industry by regulating the banking industry.
However, many appraisers feel that the situation of pressure put on appraisers to hit the right numbers is worse now than it was before FIRREA was enacted.
Today’s market bears many similarities to that of the 1980s, but this time the new player in the game is not the S&Ls, it is the mortgage broker. And like the S&Ls of the 1980s, mortgage brokers primarily deal with borrowers who would not qualify for prime loans.
In an article in the ABA Banking Journal, Gary Taylor, president of the Appraisal Institute, states “brokers were a minor factor in the mortgage business when FIRREA was written, and are not covered by the same compliance rules as banks because most are not regulated at either the state or federal levels.”
However, the article warns, “a bank obtaining mortgages through a mortgage broker is as responsible for ensuring that their broker-originator was in compliance with federal appraisal requirements as they would be for their own loans.”
An article published in the Appraisal Journal over eight years ago stated that survey data showed nearly 80% of appraisers claimed knowledge of client pressure to alter their estimated values. And certainly the trend to pressure appraisers has continued unabated since then.
The survey also revealed that mortgage brokers ranked as the most frequent source of client pressure, in part because they experience relatively less regulatory scrutiny than their commercial bank competitors.
Although the unethical pressure put on appraisers is not limited solely to mortgage brokers, numerous large institutions also wield their immense influence to pressure appraisers, pressure typically does not come from banks and credit unions who honestly want to know the true value of the property. It is the unregulated mortgage brokers, who do not “hold loans” in their own portfolios and therefore are not around to suffer the consequences of an unsound loan, that are most apt to pressure an appraiser to meet their terms or lose all future business.
A commentary by Real Estate law firm Marcus, Errico, Emmer, & Brooks notes “real estate appraisers have been complaining for some time that mortgage lenders and brokers often pressure them to make their estimates of value match asking prices rather than market reality. As long as home sales and prices were soaring, hardly anyone was listening to those warnings. But with growing signs of weakness in some segments of the housing market, the appraisers’ concerns are attracting attention in Washington.”
And the market is changing, and the change is rapid. The spiraling upward course of real estate prices leaves many analysts wondering just how long it will be until the bubble bursts.
A June 13th article in Time Magazine reveals that the median home price skyrocketed in April to $206,000, an increase of 15% in just the past year and a stunning increase of 55% over the past five years. And it is not just first mortgages that are affected by misleading appraisals. The refinancing of mortgages is at an all-time high.
Where past generations considered their house an investment, many of today’s homeowners look to their house as an easy source of cash. Time reports that in 2004, US homeowners took approximately $139 billion out of their home equity through refinancing compared to $26 billion in 2000. And although an estimated 35% of this money was put into home improvements, 42% was used for consumer purchases, to cover living expenses, and to pay off and credit cards—a move that further erodes a home’s equity.
These homeowners, especially those with ARMs, could face devastating losses when the interest rate climbs. And the combination of a climbing interest rate and falling levels in home values will leave many homeowners owing more for their mortgage than the actual value of their property. A situation known as being “upside-down” in a property.
An honest appraisal has always been a key factor in the soundness of a loan, but in these volatile times in the real estate industry, an appraisal that reflects the true value of property is even more imperative.
There is no easy answer to solving the problem of appraisals that do not reflect true value. But there are a few crucial steps that will help bring us closer to honesty in our industry.
The pending legislation is a good start. No-nonsense terminology that makes pressuring appraisers to state false values illegal and punishable by law is a necessary course of action.
Secondly, appraisers must refuse to adjust numbers. Appraisers need to remember that they are well within their rights to remind aggressive clients of the sanctions and limitations imposed by USPAP. Further, individual appraisers must take an active role in reporting their knowledge of coercion by brokers and also report fraudulent activities of other appraisers.
Third, mortgage brokers must be strictly licensed and regulated and held legally accountable for their actions. It does not take much intelligence to realize that a field where the bar is set so low for entry, and where it is so easy to make money, sets up an ultimate get rich quick scheme, a scheme that is currently allowing hundreds of unprincipled individuals to swindle not only other businesses but citizens as well.
The role of the appraiser is often seen as the bearer of bad tidings, but it is the honesty of an appraisal that keeps the system stable. Gerald Smolen and Donald Hambleton explain the process by stating, “the idealistic role of the appraisal industry holds the line on speculative property inflation. During a soaring price spiral, appraiser’s estimated values would be less than the speculative frenzy occurring in the market. The unstabilized market would steady itself as a growing number of deals failed as lenders would lower their loan-to-value ratios. In other cases, inflated deals would fail because no financing was available at the buyer’s excessive offering price.”
The entire health of the real estate industry hinges on honest and accurate appraisals. Appraisals must be allowed to be independently executed by qualified professionals with no influence from outside sources.
If they are not, the bank, and eventually those who invest in the mortgage bonds that provide the capital for the loan, will lose money. Realtors will no longer be able to make a profitable living in an infirm market. All property owners will pay the price through inflated property taxes established on a tax base that has been destabilized. And every American will be affected by paying the price for financial failures and investigations.
But, it is the homeowners themselves who will pay the ultimate price for an appraisal influenced by a loan officer or mortgage broker whose primary interest is earning a commission on the number and the amount of the loans he acquires.
The only one that stands to make a profit in an industry turned up-side-down ”is the commissioned loan originator—an individual who often takes the money and runs, giving no thought of how his actions will effect the economy, our industry, or the individuals who trust him with their most valued financial possession—their home.
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