What Is An Appraisal?

An appraisal is thought by most consumers to be an exact valuation of the home they are purchasing or refinancing. The reality is that there is no such thing as exactly valuing a home, since a home is worth what someone is willing to pay for it. And sincedifferent people are willing to pay different prices, the real value is hard to pin down, or even impossible.

I have had many appraisers tell me there job is not to value a house for exactly what they think its worth. Their job is to justify to the bank that the contract price is valid, and that the house should suffice in serving as the bank’s collateral. So 9 times out of 10 the appraisal will come in right at the purchase price. The average mortgage borrower typically cries foul and thinks the whole appraisal process is rigged. This is incorrect. An appraisal usually comes in at the purchase price because the appraiser is working for the bank, and their job is to justify that the purchase price being paid is supportable. The appraiser’s job is not as much about trying to pin down the exact value of the property, which we know is almost impossible anyway. And think about it, why would an appraiser say a house is worth $520,000 if the contract price is $500,000? They are just sticking their neck out saying a higher value is “real”, when we all know value is subjective. Some appraisals do indeed come in higher than the contract price, but now you have more of an idea why most appraisers come in at the asking price.

Another misconception is that as long as the home appraises for enough to cover the loan, then the bank should have no problem approving the loan. This is very untrue. If there is purchase contract on a at $500,000 home, and there is a $400,000 loan and the lender is offering you an 80% loan-to-value loan, that means its terms require that you have 20% equity. If the house appraises for $400,000, then your loan-to-value is 100%, and there is no equity. Loan denied. If the home appraises at $450,000, there still is not 20% equity. Loan denied. The appraisal has to be at least $500,000 to have 20% equity.

Conversely, if the home appraises over the asking price, that does not help you in any way. The lender will only lend on the contract price or the appraised value, whichever is lower.

Another important thing to note is that an appraisal is not just the act of an appraiser physically inspecting the home (and an appraisal has nothing to do with a home inspection, there is no analysis of the structure or systems in an appraisal). An appraisal inspection is just the physical analysis of the home which includes photos and measurements. I have had hundreds of clients over the years tell me, “the appraisal was done 2 days ago, why don’t I have a copy, what was the value?!” What was done was not the appraisal itself, what was done was the appraiser’s inspection of the subject property.

All the appraiser needs is measurements, general observations and photos, and they can be gone in 10-15 minutes. Then the appraiser needs to find comparable, settled sales (listings are not considered data since the price is only an asking price), shoot photos of the comps, make adjustments for differences between the comps, and research things (condition, renovation level, was a sale a distressed sale, etc). The research and follow up calls alone can take several days. Then the appraiser has to drive around to the comps he has chosen and shoot photos of those comps. Then after making all the necessary adjustments between the subject property and the comps, the final appraisal report is delivered, which can be 20-30 pages, or more, depending on the type of property. Hence, a final appraisal report can take at least a week to deliver, or more, depending on the appraiser's backlog.

Now, it has happened again, in only a week. I lost a client to a bank based in North Dakota. The bank had a rate 1/8% lower than mine. And I had even explained that a distant bank would have no relationship with local appraisers, and he was almost guaranteed to get a lowball appraisal. Here is what the client got for that 1/8%:

"The appraiser came out to my house this week. To my disappointment, he valued the house at $503K. As I said, my expectation was $553K based on a lot of research and recent sales. He mentioned that there were not too many comparable sales recently, but I disagree. It sounds like he does not know the local marketplace. So, in order to be within the 80% LTV range, looks like I need to pay a lot of the old loan amount off, out of my own pocket."

Did he get a better deal than I offered? The 1/8% equals about $29/month on his loan amount, to get that he'll likely have to pay tens of thousands of dollars of his loan off, because of what is likely an inaccurate appraisal.

I can only say it so many times everyone, then I am going to have to move on to some other blog topics, ASK ABOUT THE APPRAISER! Maybe no one reads my blogs…so no one is learning all this? Hello? Is anyone out there? Is anyone reading this? Is no one getting benefit of my 25 years in the mortgage business? PLEASE, I AM BEGGING YOU, ASK ABOUT THE APPRAISER!

Large banks, distant banks, and online lenders are very likely to be completely out of control on how they source the appraiser and the quality of the appraisal work. Search my other blogs for "appraisal" and "HVCC" if you want to know the nuts and bolts of why that is, otherwise, ASK ABOUT THE APPRAISER. If a lender cannot guarantee a local, experienced appraiser; run away; I don't care how low the alleged lower interest rate is.

I don't know how many times I'll have to say it, "WHEN SHOPPING FOR A MORTGAGE ASK ABOUT THE APPRAISER!" In fact, don't ask, just read what I have to say first. I have repeatedly said on this blog that many sources for mortgage loans are not to be trusted when it comes to the appraisal. Why? Because most lenders use large Appraisal Management Companies (AMC's) populated by dozens and dozens, usually more like hundreds of appraisers, that are coming from all over the place geographically. What has happened is this:

-The Feds changed the laws, because they are so smart, and said that individual loan officers cannot choose the appraiser, because the Feds feared collusion between the loan officer and appraiser, or the Realtor and the appraiser, on the appraised value.

-Now appraisals are ordered through the bank or lending institution, and the appraisal is ordered through a large AMC. The appraisal order is put out for bid, or ordered from the next appraiser in line. This almost assures you'll never get the highest quality appraiser. You'll get the cheapest or the lowest quality, which is inane on a mortgage application. The AMC gets an appraiser to do a $400 appraisal for $250 and pockets the difference. The large banks have turned this into a profit center. Guess what type of appraiser you'll get for that type of discounted fee? Do I even need to say it….I did not think so.

You CANNOT simply shop mortgage lenders by price, or some promises made. You have to shop appraisers, experience, fees, service, turn time, and on and on. Just picking the lowest rate is almost guaranteed to cause problems. Never in history has there been a more critical time to ask a lot of questions, and shop service first and price second.

Large banks use large AMC's where appraisers come from all over geographically. And if you get a loan through a mortgage broker you should question who they are brokering the loan through, and what the AMC is like, and where the appraiser may come from. If a mortgage broker ends up brokering a loan through a big bank, its the same result as going direct to the big bank, which means a large, unresponsive and unaccountable AMC. Make sure a mortgage broker goes to a small-medium sized mortgage banker as the source of the loan, or someone they have used before and whose AMC they know and trust.

A mortgage banker (i.e. a Direct Lender) usually sets up their own AMC, populated with a small group of appraisers who are all local, and whom they know, and as a result they can trust the quality of the appraisal work. So these days, a mortgage banker/direct lender is always a good source for a sound appraisal.

"Why does this really matter", you ask? "What is the harm in letting any licensed appraiser come out to appraise the home, right?" "Isn't the appraised value of the home the appraised value of the home, no matter which appraiser comes out?" NO! If you send out 10 different appraisers to appraise a home, you'll get 6-8 different appraisal values. Below is a very recent story to help illustrate:

I had a potential refinance client who ended up using another lender. I tried to explain why a local lender like myself would be better able to get a more accurate and successful appraisal, and since my rate was the same as all others he had heard, he should use me. But he said:

"I am going to use the large bank I worked with before when I bought the place. They are going to make it easy on me." I always fume when I hear that. What exactly does that mean, "make it easy"? How? Did you ask how? Or did they just say, "we'll make it easy on you since we already have the loan" and you just believed it? I truly believe that in some big bank marketing manual it says, "tell people we'll make it easy on them since we already have the loan, they'll simply believe it without question." Fannie Mae, Freddie Mac, FHA and VA all require the same paperwork of each lender, no matter who is presently servicing the loan. It is literally impossible for one lender to make it easier than another, the requirements are universal!

The client ultimately said, "I regret to tell you that I have decided to go with a different lender. I ended up choosing the same lender who carries the mortgage now. Turns out, they'll make it easy on me, and I am comfortable since we have interacted with them for several years. But thank you for your time, I can tell you are efficient and anyone that my neighbor refers must be good, we have high regard for her. We will consider you in the future"

I thanked him for checking in with me, and wished him well. I followed up a few months later to make sure he got his mortgage OK, and that everything worked out as planned. His reply was astonishing:

"Brian, thanks for checking back in. It turns out the house appraised for $625,000, which is $85,000 lower than my lowest expectation. I had to bring $45,000 in cash to the settlement table to pay the loan down. On the positive side, they lowered the interest rate by 1/8% to 4.875% on the 30 year fixed. Thanks for checking in."

Huh? I offered him 5% in the beginning which is where the market was at the time, and it sounds like the large bank he chose started him at 5% only to drop his rate 1/8% to 4.875% at a later date. So that is good for him, that interest rate drop saved him about $33/month on the size loan he was refinancing.

More importantly, had he had a local appraiser that knew the marketplace I bet his house would have appraised for what the thought it should, and he would not have had to pay his loan down by $45,000! Did you hear me? I said he had to pay his loan down by $45,000! Who does that? But hey, at least they made it easy on him, and he saved another $33/month on that lower rate they gave him.

Let's see if I can do that math. He spent $45,000 to pay the loan down, he is saving $33/month more.

45,000 divided by 33 = 1,363

That means in 1,363 months he'll break even on the $45,000 cash outlay. 1,363 is 113 years. Hope he is in good health….

ASK ABOUT THE APPRAISER!

I am working on an interesting loan that will make for a good case study someday, and I think homebuyers and Realtors will find it interesting too.

I am doing a loan for a homebuyer to buy a single family detached home in Falls Church, Virginia. The sales price was a little over $500,000 and the new loan is a Conventional Fixed rate 80% loan-to-value loan, which of course means we are subject to the HVCC rules. So I ordered the appraisal from the bank's Appraisal Management Company (AMC).

For once, the appraiser was local, from Falls Church, VA so we all figured this appraiser would know the local marketplace and that we would be getting an accurate and fair appraisal. But the appraisal came in several weeks later at a price approximately $35,000 lower than the sales price. The seller was angry, the Realtors were upset, and the buyer was confused.

I challenged this appraisal, sent in new comps to support our challenge along with a narrative explaining why we thought we were on solid ground and why we thought the home was worth the contract price. But our challenge was rejected.

We tried a second bank, and a second appraiser, since we were firmly convinced we got a bad deal from the first appraiser. The second appraiser was from Cumberland, MD! How in the world did an appraiser from almost 140 miles and 3 hours away think he knew the Falls Church, Virginia marketplace for real estate?!

To our astonishment, the appraiser used solid comparable homes, and the appraisal came in at the contract price, and we will be going to settlement soon.

But this was another HVCC accident waiting to happen, and another reason that the HVCC rules need to be changed, halted, or stopped! We got lucky that the Cumberland, MD appraiser somehow found very accurate comparable sales in Falls Church City, VA. What if we had the same fate as the first appraisal? The whole HVCC system needs to be revamped to avoid appraisers who are on the verge of going out of business from taking business way outside their marketplace in a weak attempt to scramble and raise cash to pay the bills. The consumer deserves a more professional assessment, and the whole industry deserves more accuracy and responsiveness.

HVCC, the acronym for “Home Valuation Code of Conduct”, is the result of a legal settlement between NY attorney general Andrew Cuomo and Fannie Mae & Freddie Mac to assure that appraisers would not be unduly influenced by lenders in the appraisal process. Before this ruling, mortgage brokers and bank loan officers would order the appraisal for a new home loan from any licensed appraiser, usually one they knew professionally for many years. After this ruling, appraisals are not allowed to be ordered by the mortgage broker or loan officer, the bank now orders them from an "Appraisal Management Company" (AMC). Mortgage brokers and loan officers are no longer allowed to have any direct contact with the appraiser.  Appraisers are supposedly being more scrutinized by the AMC's. The law became effective on May 1st 2009 and has been causing problems ever since for buyers, sellers, and industry professionals across the country.

With evidence of mismanagement and fraud in the industry in the past, the attempt to ensure that residential properties are not appraised for more than their true worth is understandable. The intention was to stop lenders from pushing appraisers for higher values to help "make the deal work." The belief was that this, in part, is what drove property values to unrealistic levels. The process under the new law takes ordering the appraisal away from anyone with a vested interest in getting the loan done.

But, as often happens, the attempt to right a wrong in an industry becomes over-regulation or has unintended consequences. We are losing excellent, qualified appraisers due to the effect the law is having on their incomes. Now, the orders for appraisals are being sent by Appraisal Management Companies (AMCs) to those who charge the least and have the least experience. AMCs rotate the appraisal orders through their members, tacking on a fee for doing so. Good appraisers who have grown their businesses based on their contacts and relationships in the industry with mortgage brokers and loan officers, are now competing side by side with newer appraisers who will work for less. Some of the downsides of the new process are:

-Appraisal costs have gone up so AMC's can take their piece of the fee. A standard appraisal fee was $350, it is now $400-$500, and the AMC may take half, leaving half for the appraiser. It used to be that the appraiser got 100% of $350, now they may get 50% (or $225) of $450. So you can see how the cost has gone up to the consumer, and…

-Excellent appraisers have been leaving the industry since they are suddenly working for substantially less money.

-Accuracy in appraisals has been reduced, since less experienced appraisers willing to work for less are now competing for appraisals.

-Appraisers are coming into a marketplace like Washington DC from Frederick, Richmond and points beyond, with no idea how the local marketplace works! Before this new ruling local appraisers were hired who knew the market and usually had street level knowledge of the neighborhood they were appraising.

-Should the loan not go through, the consumer must start the process all over again and get a new appraisal with a new lender. This not only adds even more cost to the buyer, but adds a lot of time to the loan processing as well.

Consumers are paying more for appraisals now. Yet, these are the very people the law was designed to protect! Appraisers have seen their income approximately cut in half. Lenders are finding it takes much longer to get an appraisal from someone they have no contact with and no history with, so turn-around times are rising and loan processing times are increasing. Lenders are having trouble meeting settlement dates in contracts.

And the Feds that dreamed up this new policy for Fannie Mae and Freddie Mac thought this would  help how?

I do believe that there has been occasion where a lender pressured an appraiser to "make a deal work" and make sure a home appraised at a contract price. And I do believe there have been Realtors that have pressured lenders to pressure appraisers to make a deal work. But I think this was the exception, by far, as you cannot make up fake comparables or make up values for a home. There is also something called "the underwriting process", let's not forget it is difficult to get improper comps past an underwriter. And I simply think there must be a better way to root out the occasional fraud. Common sense? Buyer beware? Require two appraisals? Require appraisal reviews? There has to be a better method beyond overbearing, problematic, and ineffective federal policy.