Monday, May 3, 2010

Paying for Protection: My House is Worth What?

In 2008, Andrew Cuomo, attorney general of New York, agreed to drop a investigation into Fannie Mae and Freddie Mac if both agencies would agree to sign the Home Valuation Code of Conduct (HVCC). This code of conduct would govern the way that appraisals were handled on loans which were sold to either Fannie Mae or Freddie Mac, which is estimated to be about 70% of residential mortgage loans in the United States.

The provisions of HVCC included bans on pressuring appraisers to arrive at a certain value and refusing to pay for an order which did not meet value (activities which were already illegal.) But HVCC went beyond that by requiring that neither the loan originator nor any employee of the company who would be directly compensated on the transaction have any contact with the appraiser whatsoever. In large banking institutions, this meant that the appraisers could be ordered by a separate department of the bank. However, the new regulation stated specifically that no mortgage broker or employee of a mortgage broker could order an appraisal or have any contact with the appraiser.

This piece of rulemaking by one attorney general in one state has affected the way that home buyers and home owners all over the United States receive their home values. Because of the absolute ban on personal contact between the loan originator or their staff and the appraiser, the rule made possible the explosive growth of AMCs--Appraisal Management Companies--who would act as the middle man in the transaction by placing the order and paying and compensating the appraiser.

This is one of the few cases where adding an additional middle man was touted as a cost savings measure. AMCs were certainly not new; they had been around for years, but they were not widely used because they added a lot of cost for the consumer and they were very inefficient. Cuomo's new rule gave AMCs a huge boost since they went from a cumbersome, expensive mechanism nobody really preferred to the only acceptable way of receiving an appraisal for most mortgage loans.

Interestingly, the abuses that led to this rule being adopted did not involve mortgage brokers or small independent shops at all--it was a case involving the now defunct Washington Mutual, which was taken over by JP Morgan Chase, and an AMC. Washington Mutual was apparently pressuring the AMC to pressure the appraisers who worked for it to hit certain values. It is also interesting to note that Cuomo, who is now favored to win his race for governor of New York, is rumored to sit on the board of an AMC.

The rule became effective May 1, 2009. In the old free enterprise days of appraisals, appraisers who had been in the business a long time had spent many years building their companies, participating in community events and marketing their services. The proliferation of appraisers in recent years kept costs down because they had to be competitive in pricing. And, of course, the broker and lender community knew by reputation and experience which appraisers did a good job.

With HVCC all of that disappeared. Reputation and relationships no longer matter. All appraisers have to be signed up to work for AMCs and the AMCs hire them--or don't--based on whatever rotation system they have worked out. Of course, AMCs are not charitable organizations, so they make money in only one of a few ways: 1. They raise the price of the service. 2. They pay the appraiser less. 3. They do both.

A residential appraisal in El Paso used to cost about $350.00 for a regular appraisal. An appraisal of an investment property was about $450.00. Today most appaisals run right around $400.00 and an investment property appraisal is between $530.00 and $630.00. A review that used to cost $150.00 now costs around $280.00. Lenders have a list of AMCs they use, and they assign the work to whatever AMC they want the appraisal to go to. The AMC then picks the appraiser from their list. There is no way to shop for a better price.

There is also no way to look before you buy. Before May of last year, we as the originators could talk to the appraiser about a property before we took the borrower's money. If we determined that the property was not going to appraise based on our conversation, we could advise the borrower that they were proceeding at their own risk.

But the worst and most expensive part of the new system is that there is no recourse for a bad appraisal. HVCC specifically prohibits a lender from ordering a second appraisal if the first one does not come in. The originator can submit additional comparables to the AMC, but the appraiser can reject them. I have never seen an appraiser adjust a value based on new comparables since this system went into effect. Further, since all lenders are afraid that the appraisal will not be HVCC compliant, it is very hard to transfer an appraisal, so if for any reason the loan is declined by one lender, the borrower basically has to start over and pay for a new appraisal with a new lender.

How does it work in real life? Last July I financed a home for a doctor and his wife. They had found a new home in an upscale neighborhood, and they and the seller agreed to a contract price of $360,000. The couple had strong credit and very high income and savings, and they were making a 20% down payment. We got credit approval immediately and then ordered the appraisal. About 10 days later, the appraisal came in for $270,000.00. When we reviewed it to see why, we found that the appraiser used a comparable on the same street which had been sold as a foreclosure. (Foreclosures are not supposed to be used as comparables for full price sales). I asked the seller's agent about why she priced her listing the way she did. She assured me that her listing was not overpriced, that it offered many amenities, and that sales in the area did support it. She sent me some comparables which I sent to the AMC. A few hours later, the AMC sent me the appraiser's response. The appraiser, who was actually from another city, responded that he did not work for us anymore, he did not have to change anything and did not plan to.

To make the contract price work, the seller would have had to lower the price by $90,000 (which they were not going to do) or the buyer would have had to bring in an additional $90,000 in cash on top of the $72,000 they had already planned to put down (which they were not going to do). The borrowers wanted to know if they had any other options, and I told them that the only thing I could do was start over and send the loan to a new lender who would order a new appraisal. This appraisal would cost an additional $350.00, and I had no guarantee that it would turn out any better than the one we had just received. Since the borrower really wanted the house, they agreed that this was the best course of action, with the idea that they could probably renegotiate a lower sales price with the seller if the appraised value were more reasonable.

We resubmitted the loan to a new lender and about ten days later we got our new appraisal. The value was $360,000. This appraiser did not use any foreclosures. He took great photos of the house and compared it to other houses with similar amenities. The underwriter accepted the appraisal with no revisions and the buyer and seller closed at the contract price. The difference between these two reports--the individual preparing them. Both appraisers had nothing to work with but an order and sales contract, but the first one had a mindset that the house was only worth $270,000 and that was all that he was going to appraise it for.

An appraisal is just an opinion of value. Accurate appraisals require skill, training, and a thorough knowledge of the real estate market. The new rules regarding appraisals attempt to trade seasoned professionals for anyone with a license who will work cheaply. HVCC costs consumers money in additional appraisals they would not otherwise have incurred, and it can cost homeowners thousands of dollars in equity in their homes.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at

1 comment:

  1. Oh Alexandra! All that you have shared is not only so very true but reminds me of how "Uncle Sam's" gesture to help the American people has actually hurt the them. I sure hope our local representatives get a copy of your blog in the hopes Congress can reverse the course it has allowed for the folks it serves. If not, I fear that 'big brother' will eventually be directly telling us which homes we can buy...and which ones we cannot. For, isn't this in effect what they have subliminally done via the HVCC protocol? Art