With home prices climbing at a double-digit pace in many parts of the country, lenders are increasingly worried about inflated appraisal...
With home prices climbing at a double-digit pace in many parts of the country, lenders are increasingly worried about inflated appraisal values — and some are taking steps to clamp down.
U.S. Bank Home Mortgage, a unit of U.S. Bancorp, has increased the number of in-house appraisers on its staff roughly 40 percent in the past 18 months — cutting down its reliance on outside appraisers. The Minneapolis lender also is doing more audits of appraisals produced by outside firms, particularly in areas where home prices have been climbing rapidly.
Some lenders are getting pickier about the appraisers they do business with — a policy that is easier to enforce now that refinance activity has slowed. At IndyMac Bancorp, the pace at which new names are added to the lender’s “exclusionary” list of overly aggressive appraisers has increased fourfold in the past year, says Executive Vice President Frank Sillman.
Some lenders also are turning to computerized models to weed out inflated valuations. National City Mortgage, a unit of National City, last year rolled out an automated system designed to flag the 5 percent to 10 percent of appraisals that need additional review. IndyMac added an automated system last year as well. Washington Mutual says it is testing new tools that would provide “automated, independent information about a home’s value.”
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Federal banking regulators also are looking more closely at how lenders are managing the appraisal process out of concern that it is a factor in the overheated real-estate market.
The fluid nature of appraisals has long been an open secret in the real-estate world. Now, the fast-moving housing market has increased worries that inflated appraisals could lead to problems. There are fears overly generous appraisals will add fuel to a speculative housing market by feeding expectations that prices will continue to rise rapidly.
Such fears come on top of concerns about mortgage fraud, reports of which have soared in recent years, according to the Federal Bureau of Investigation. In some mortgage frauds, appraisers act in collusion with borrowers to provide misleading valuations, the FBI says. In others, properties are falsely appraised at a higher value and then quickly sold.
Borrowers, lenders at risk
Appraisals are designed to protect lenders and homeowners alike from overextending themselves when taking out a home loan. When the appraisals are inflated, borrowers can wind up owing more than their home’s value, even if prices don’t fall. Lenders also can be left holding the bag if the loan isn’t repaid. The risks are heightened when borrowers are taking out loans for most, or all, of the purchase price, as is often the case today.
Coming up with accurate valuations can be particularly tricky in hot markets where home prices can jump by tens of thousands of dollars in a matter of months.
“We find it more difficult to find comparable properties” — a key tool in setting a valuation — says Rob Snow, head of retail lending at ETrade Financial. “If each property on the block sells for $50,000 more, it’s very hard to get an accurate value.”
ETrade has been scrutinizing appraisals more closely since it launched a unit last year that focuses on loan-closing services.
Of course, plenty of lenders and appraisers adhere to good practices. Still, appraisers say they are sometimes pressured to increase valuations, directly or indirectly, by mortgage brokers, loan officers and real-estate agents, all of whom are eager to make sure a deal is completed. About 55 percent of appraisers say they have felt pressure to overstate the value or condition of a property, according to a 2003 survey by October Research, a provider of news and information to the real-estate-services industry.
Unlike mortgage brokers or real-estate agents, appraisers are paid whether or not the deal is done. But appraisers fear that they will lose business or won’t be paid if they state a property’s true value.
The Appraisal Institute is pushing for legislation that would prohibit inappropriate pressure on appraisers. “The issue of appraiser independence is the No. 1 issue we hear about from our members,” says Bill Garber, the group’s director of government affairs.
In a fast-moving market, even buyers can be eager to get an appraisal that matches the purchase price, so the deal can close.
Typically, appraisals are paid for by the borrower, usually as part of the loan-application process. Under federal rules, the borrower doesn’t get to pick the appraiser. The lender can pick the appraiser, but to protect against conflicts, federal rules say the person commissioning the appraisal shouldn’t also be making the final loan decision. In practice, the actual choice can be influenced by the mortgage broker, loan officer or real-estate agent.
Practices draw scrutiny
Many of the nation’s leading mortgage lenders are focusing more closely on their appraisal practices. Bank of America this month posted a notice for its mortgage lending staff highlighting the issue of inflated appraisals and how the bank works to protect against them.
In some cases, lenders are requiring a second opinion. Tom Freeze, an appraiser in Newport News, Va., says lenders have begun asking for two appraisals on properties valued at more than $1 million and on purchases by buyers with less-than-stellar credit scores.
Investors who buy mortgage-backed securities also are paying attention. “We just assume that appraisals are a little lofty, and don’t believe there’s as much value in the house as we’re being told there is,” says Scott Simon, a managing director with Pimco, a Newport Beach, Calif., asset-management firm. In part because it fears appraisals are too high, Pimco is demanding deals be structured to give it more protection against potential losses.
Part of the problem is inflated expectations. “Buyers are still in a state of panic and sellers are still in the greed mode,” says Sara Schwarzentraub, president of Inter-State Appraisal Service near San Diego, Calif. “There are a higher percentage of (deals) where we think the numbers are unrealistic.”