A common-sense way to mend the draconian appraisal process
If federal regulators are truly concerned about the quality and independence of home appraisals - a cornerstone of sound mortgage lending - why don't they simply prohibit appraisers from learning the contract price before they perform their assessment of a home's value?
Instead of this commonsense solution, regulators continue to come up with schemes that govern how appraisers are chosen - and which simultaneously drive up prices to consumers while cutting the income of appraisers.
On April 1, a new regulatory scheme called Appraiser Independence Requirements, will go into effect. This AIR replaces the much-maligned Home Valuation Code of Conduct but does little to improve it. Both AIR and HVCC were designed to ensure that the home valuation process conducted by appraisers is conducted in a strictly independent manner. Unfortunately, in practice AIR continues the legacy of HVCC, causing borrowers to pay more for their appraisals and appraisers to earn less for their work.
Appraisals "gone wild" were, at least in part, to blame for the housing meltdown. In some cases, real estate agents, mortgage loan officers and others whose livelihoods depended upon home purchases and refinances going to settlement exerted undue influence on appraisers. In an effort to correct this, regulators have set out to change the way home appraisals had been conducted for decades.
Those changes became law when President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act in July. That law tasked the Federal Reserve and other agencies to promulgate regulations that, among other things, sought to make sure that appraisers' independent judgment would not be tainted by any influence or pressure from those having a financial interest in the underlying transaction.
AIR applies to all loans sold to Fannie Mae and Freddie Mac originated for the acquisition or refinancing of one- to four-unit residential properties. It does not apply to FHA or VA loans. AIR seeks to restore independence to the appraisal industry by prohibiting coercion, bribery, collusion, conflicts of interest and other similar activities; prohibiting appraisers and appraisal management companies from having a financial or other interest in the property, and mandating that appraisers receive reasonable and customary compensation for their services.
For decades, appraisals were the domain of the loan officer. After the officer had taken a loan application, part of his or her duties would be to directly order a home appraisal. Over time loan officers would get to know the local appraisers and select those that they felt they could trust to obtain an honest, timely and complete valuation. After all, the honest valuation of the property was of critical importance to the underwriter who would approve or deny the mortgage loan. Loan officers would collect the appraisal fee upfront from the borrower- often no more than $200 to $300, all of which would be paid by the loan officer directly to the appraiser upon commencement of his written appraisal report.
As the real estate market began to heat up in the new millennium, in too many cases, honest, independent valuations became of secondary importance. What became of primary importance was "hitting the number"- the contract price in a purchase transaction, or the desired loan amount in a refinance - and closing the loan.
To correct these excesses, AIR errs on the side of absolute isolation of the appraiser from any undue influence. Loan officers are absolutely prohibited from ordering appraisals. In fact, AIR prohibits lenders from relying on an appraisal if the loan officer had any role in selecting, retaining or compensating the appraiser. The non-sales staff of mortgage lenders may order appraisals directly from appraisers.
To accommodate this draconian "cone of silence" between appraiser and loan officer, something called an Appraisal Management Company has come into use. Although these types of companies have long been used for sourcing commercial appraisals, their widespread use in the residential context is relatively new. Now virtually all lenders are arranging appraisals through an AMC.
The AMC's role is to source appraisers who are willing to work for prices that in virtually all cases are less than they had earned when they were being retained directly by loan officers. Loan officers I've spoken with say that, where experienced appraisers pre-HVCC were earning about $300 per appraisal, now AMCs pay them between $150 and $250. But borrowers' cost for appraisals now ranges between $450 and $600, with the extra money used to pay the AMCs for arranging, and sometimes for reviewing the appraisal.
Loan officers have been forced to sacrifice trust in their known appraisers for anonymity. Instead of being able to winnow out the incompetent from the competent appraisers over time, now the loan officer must rely on the luck of the draw and on the ability of a far-away AMC to substitute its judgment as to the appraiser's competency.
Incredibly, despite AIR's avowed mission of maintaining the integrity of the appraisal process by strict separation of loan officers from appraisers, AIR permits lenders to own all or part of an AMC - and to require its loan officers to order appraisals from its own AMC.
This apparent loophole appears to eviscerate the spirit of the AIR regulation.
If the regulators are truly intent on creating an independent appraisal industry with valid, untainted valuations based solely on the professional judgment of the appraiser, they should simply prohibit the appraiser from learning the contract price. Regulation could require that the purchase price be redacted from the sales contract before being delivered to the appraiser.
If appraisers were not privy to the actual contract price there would be no subliminal or overt influence leading them to arrive at that valuation.
Harvey S. Jacobs is a real estate lawyer in the Rockville office of Joseph, Greenwald & Laake. He is an active real estate investor, developer, landlord, settlement attorney and lender. This column is not legal advice and should not be acted upon without obtaining your own legal counsel.