Wednesday, November 07, 2007

What about Larry?

I have been ordering appraisals from Larry for the last ten years. Larry is a licensed appraiser and a member of the Appraisal Institute. Last week I called him to discuss a home’s value. A former client is refinancing an existing loan and was concerned that his property may not appraise high enough to allow the refinance.

“Hi Larry, have you had a chance to review the numbers on the Jenkins property? They really need $450,000 or they can’t do the loan.” “No problem Ken, it’s a stretch but I think I can hit their number.” “Thanks Larry, I own you one. I’ll buy lunch next Friday.” Did I break the new law against influencing appraisers?

Earlier this month, Governor Schwarzenegger signed into law SB 223 making it illegal to pressure appraisers to arrive at a predetermined property value that's been set by mortgage brokers or homeowners to ensure a sale or refinance goes through. The new law makes it illegal for a licensed appraiser to engage in "any appraisal activity in connection with the purchase, sale, transfer, financing, or development of real property if his or her compensation is dependent on or affected by the value conclusion generated by the appraisal."

Some housing experts believe that inflated appraisals have significantly contributed to the mortgage-meltdown crisis. The law is supposed to deter interested parties from putting pressure on the appraiser to reach a predetermined value on the property. The new law makes violators subject to punishment of license suspension or revocation with the potential of civil action.

The state isn’t alone in passing legislation designed to safeguard an appraiser’s independence. Congress is getting into the act. Under consideration is HR 3837, entitled the Escrow, Appraisal and Mortgage Servicing Improvements Act. If enacted, the bill would prohibit interference by loan originators in appraisals. The bill will ban all forms of “compensation, coercion, extortion, collusion, instruction, inducement, bribing or intimidation for the purpose of causing the appraisal value assigned to the property to be based on any fact other than the independent judgment of the appraiser.” The bill prohibits efforts to force appraisers “to hit a targeted value.”

The new appraisal protection law puts on the books what has always been understood between ethical professionals. Current standards of practice already prohibit an appraiser from accepting compensation based upon a predetermined value. The law’s enforcement will be difficult. Unethical behavior between two consenting adults is seldom made public. I don’t think you can regulate bad people. Bad people ignore the laws and bend the rules regardless of additional regulations. Who defines the degree of pressure put upon an appraiser? If before ordering an appraisal, I discuss my opinion of the property’s value with the appraiser using persuasive language, (please, please) have I committed a crime?

Lawmakers are over simplifying the problem if they believe the current market correction is the result of widespread collusion between lenders and appraisers on property values. Although there will always be unethical behavior, over-valued appraisals were a rare occurrence even at the peak of the market in 2005. The few that have been discovered are sensationalized. The high demand for homes drove inflated property values at such an accelerated pace it was difficult to know how high was too high. It all seems surreal two years later.

An appraisal is an art not a science. It’s one individual opinion of value and therefore subject to interpretation. The appraiser’s opinion of value is reflected in the appraisal report but it is always subject to further reviews and scrutiny. The lender’s underwriter always reviews the appraisal for accuracy and many jumbo or subprime loans are further reviewed by an in-house review appraiser or outside appraisal service. The buyer and the selling agent should always request a copy of the appraisal from the lender and have no hesitancy in asking questions about how the value was determined. Recently, I acted as an expert witness in a contested property settlement. The court reviewed four appraisals all completed within the past six months. Not only were they all different but the gap between the highest and lowest was over $100,000. In that case the judge had the final say on value.

As long as the financial success of an appraiser is directly linked to the mortgage broker’s success in closing loans, there will be the potential of influence and “hitting the number.” Despite the law’s intent, an appraiser who consistently appraises property values below the negotiated purchase price, therefore derailing the deal, need not be concerned about being overworked in the future.One way of preventing undo influence on an appraiser is to rework the appraisal ordering process. Currently, most appraisals are ordered by mortgage lenders, based upon a personal relationship. Removing the personal relationship may result in more objective opinions of value. Cal-Vet has a different approach to the appraisal ordering process. The mortgage broker does not order the appraisal. Cal-Vet orders the appraisal from an approved rotating list. I suspect that some large lenders may try the clearinghouse approach to ordering an appraisal thereby removing the mortgage professional from the entire process. But why stop there? Who’s next on the list for a listing? What bank is in line for the next loan? Good appraisers don’t need additional regulations to tell them how to do their job and bad ones won’t care.


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