May 17, 2012

The two most important pieces of information mortgage applicants should have in entering the market is their credit score and the appraised value of their property. The first is easy, they can get free estimates on the web, or buy their score for $25 or so. When they apply to a lender, one of the first things the loan officer will do is pull their credit on-line, which takes only a few minutes. 

Appraised value is another matter entirely. It has to be ordered by the lender after the borrower has applied for the loan. In most cases, the order goes to an appraisal management company (AMC) which selects the individual appraiser who does the work and delivers the appraisal report to the AMC, who delivers it to the lender, who delivers it to the applicant.

This clumsy process, largely dictated by regulation, imposes heavy costs on borrowers relative to a system in which borrowers order their own appraisals from AMCs. This article and the one that follows describes the costs of the current system relative to the alternative, which would not be difficult to implement. 

Appraisals Can Only Be Used Once

Borrowers pay for the appraisal but it carries the name of the lender who ordered it. For all practical purposes, the appraisal belongs to that lender because the borrower cannot use it with another lender. While nothing prevents borrowers from purchasing appraisals on their own, lenders will not accept them, which means that they will have to pay for a second appraisal when they apply. And if by chance they decide that a lender other than the one they selected initially is the one they want, they will pay for (and wait for) still another appraisal.

In the alternative system where borrowers order appraisals, one appraisal could be used with any number of lenders within the 120 day validity period specified by current regulation.

No Early Warning on Loans That Don’t Work

In the existing system, consumers are denied the opportunity to see the appraisal when it will do them the most good – which is before they apply for a mortgage. In many cases, having the appraisal early on would save the consumer from a bad decision – the decision to apply for a loan for which they either cannot qualify, or which is too costly to pursue, because the property value is insufficient. This is not a rare occurrence, and when it happens it wastes the lender’s time as well as that of the applicant.

In the alternative system where borrowers order appraisals, they would be ordered before applying for a loan. This would avoid the costs incurred when a low appraised value aborted a transaction.

Loan Process Is Extended

Because appraisals are not ordered until the borrower has selected the lender, the loan process is extended by the time required for the appraisal. This is a minimum of 12 days. If the appraisal delays the transaction to the point where the rate lock expires, the borrower is exposed to a possible rise in market rates.

To avoid that risk, I advise refinancing borrowers to lock for 45 days instead of the 30 that was common before the financial crisis, and purchasers to lock for 60 days instead of 45. This 15-day increase in the lock period can cost as much as ¼ of a point – or $500 on a $200,000 loan. This cost of appraisal-induced delays is like a tax imposed on every borrower.

The alternative system where borrowers order appraisals would eliminate the tax.

Damper on Shopping

Lender-specific appraisals dampen the ability or willingness of mortgage borrowers to shop, which is hard enough without it. The disclosures that government requires lenders to provide applicants are supposed to protect borrowers by making it easier for them to shop. However, borrowers don’t receive the disclosures until after they have applied for a loan and paid for an appraisal. For a borrower to withdraw at this point in order to begin again with another lender is difficult under any circumstances. The certain knowledge that doing so will require another appraisal fee makes it doubly so.

Assuring Appraisal Independence

An important policy objective is protecting appraisals from pressure exerted by any of the parties with a vested interest in the outcome. This was the major purpose of the Home Valuation Code of Conduct (HVCC) which became effective May 1, 2009  and which has substantially changed the appraisal landscape.

The crux of HVCC was an “Appraisal Independence Requirement”, under which mortgage brokers and Realtors could no longer have any contact with appraisers, and lenders had to obtain appraisals in some manner that prevented them from exercising any control. In order to protect themselves from liability, most lenders today order appraisals through appraisal management companies (AMCs).

The theory was that lenders influenced appraisals through contact with appraisers, and if the AMC stood between them, the process would be clean. But this overlooks that the lender is positioned to direct a continuing stream of clients to the AMC, and won’t do it if the appraisals that come back don’t meet the lender’s expectations. Similarly, the AMC is positioned to direct business to appraisers and won’t if the appraisers work products makes the AMC unhappy, which will be the case if the lender is unhappy.

Having borrowers purchase appraisals directly from appraisers is not a good idea because borrowers could shop for the appraiser that would do the borrower’s bidding. But in purchasing appraisals through AMCs, borrowers would have very little leverage -- much less than lenders because each borrower transaction would be a one-shot deal.

Quality of appraisals

A much noted feature of the growth of AMCs as intermediaries in the appraisal process is a decline in the quality of appraisals. While some lenders select AMCs on the basis of price and service, lenders that have affiliated business relationships with AMCs direct their business to them. Affiliated AMCs are chosen because the lender shares its revenues, not because the AMC has well-paid appraisers, or appraisers located in proximity to the subject property.

All the major lenders have affiliated business relationships with AMCs. That is why one hears frequently about appraisals being done by appraisers who are not familiar with the local market.

If borrowers ordered appraisals from AMCs, they would select an AMC with local appraisers on their rosters, because AMCs would emphasize this in marketing to consumers. Some AMCs might also disclose what they are paying appraisers, or what amounts to the same thing, what they are retaining for themselves, as a way of emphasizing the quality of their appraisals.

Appraisal Fees

Under existing arrangements, AMCs must compete for the business of lenders who refer borrowers to them. Such competition results in higher marketing costs for AMCs, and in revenue splits of affiliated business entities that are favorable to lenders. The result of this kind of competition is higher appraisal fees paid by borrowers. Appraisers in turn must compete for the business of AMCs who retain them to do appraisals. The result of this competition is lower fees for appraisers and poorer quality appraisals. Nobody competes for the borrowers, who pay higher appraisal fees for poorer quality appraisals.  

If borrowers ordered appraisals from AMCs, lender would be out of the process, and good riddance. AMCs would then have to compete for the patronage of borrowers, which would reduce appraisal fees.  

Implementation

It should be public policy to have appraisals ordered by borrowers and have such appraisals accepted by all mortgage lenders. The key to implementing this policy is acceptance by Fannie Mae, Freddie Mac and FHA of appraisals carrying the borrower’s name rather than the lender’s name.  

Borrowers who order their own appraisal and require an FHA mortgage will face two special problems, both of which are solvable. Problem 1 is that FHA will only accept appraisals from FHA-approved appraisers. This means that a borrower who may need an FHA must inform the AMC that they need an FHA-approved appraiser.  

Problem 2 is that FHA makes it difficult to use the same appraisal twice. It assigns a case number to every application which is stamped on the appraisal form. This makes the appraisal non-useable by a second lender unless the first lender attests that the borrower was not rejected! Not surprisingly, lenders who are rejected by borrowers are reluctant to assist their competitors, so this rule has the effect of locking FHA borrowers into dealing with the first lender to whom they apply.

But borrowers ordering their own appraisal could defeat this regulatory inanity in a very simple way. When they shop, they provide the lender with a copy of their appraisal but not the original upon which the case number is attached. They hold on to the original until they are prepared to make a commitment.