When it comes to getting a mortgage, appraisals are an essential part of the process.
They establish the value of the collateral for the loan and they are prepared by licensed appraisers and must conform to the Uniform Standards of Professional Appraisal Practice (USPAP).
With the credit crisis, it has come to light that there have been substantial abuses in the appraisal process. Efforts are under way to tighten the process and make appraisals more reliable for investors.
Appraised values for residential properties are determined by the sales comparison method. This means the appraiser tries to find three similar properties very near the subject property that have been recently sold and compares their sales prices to the house being appraised.
If the home being appraised is a tract home, and there have been several recent sales of similar models nearby, this is a fairly easy process for the appraiser.
However, most of the time this is not the case, or the most recent sales are for properties that are similar but not identical.
The appraiser now has to make adjustments to compensate for differences between homes. All adjustments are based on what the appraiser determines to be market price differences (i.e. what a willing buyer will pay for the added amenities).
For example, if two of the comparable sales have a pool and the property being appraised does not have a pool, an adjustment has to be made for this difference. This same concept is applied to about 20 different variables including lot size, gross living area, number of bathrooms, quality of construction, view, landscaping, size of garage, proximity to schools, shopping, etc.
The final number, therefore, is based on sales history and an appraiser’s judgment.
Appraisers don’t make adjustments for what a homeowner actually spent on improvements to his property. Instead, they have to focus on what buyers are willing to pay for specific amenities. As an example, if you spend $25,000 for dual pane windows when preparing to sell your property but they only add $10,000 to the comparable sales price, the appraiser would be obligated to take the lower value.
The appraiser has considerable leeway in picking which comparable resales are to be used for the appraisal. This is one of the areas that has been subject to abuse.
There have been many over inflated appraisals during the past several years. To address this, many lenders have been looking much closer at appraisals and have been utilizing their internal appraisal review departments.
In many instances, this has caused appraisals to be reduced and certain appraisers to be taken off their approved appraiser lists.
In addition, in March Fannie Mae and Freddie Mac (the largest purchasers of loans in the country) began seeking industry and public input on new appraisal standards they agreed to implement under a settlement with New York Attorney General Andrew Cuomo.
According to Origination News, a mortgage industry periodical, “Under the March 3 settlement, the two mortgage giants cannot purchase loans from a lender that uses in-house appraisers or affiliated appraisal firms. On brokered loans, wholesale lenders must certify in representations and warranties that the mortgage broker did not select the appraiser.”
A copy of Fannie Mae’s “Home Valuation Code of Conduct” can be obtained at http://www.fanniemae.com/media/pdf/030308_agreement.pdf.
“The New York attorney general expects the new standards will reduce inflated and fraudulent appraisals and help insulate appraisers from lender pressure,” Origination News said.
“On the other hand, ‘A full and open comment process might prevent potential problems,’ according to the American Banker’s Association, which is concerned the new standards might ‘potentially remove thousands of appraisers’ from the marketplace and ‘delay or prevent borrowers from refinancing out of troubled subprime loans.’”
Since appraisals are such an integral part of the loan process, these recent efforts to strengthen appraisal standards are vital to minimize fraud and over-inflated appraisals and help avoid another credit crisis in the future.
Mike Ferguson is with Windsor Financial Services located in Granite Bay. His Web address is www.windsorFS.com.
