December 11th, 2012 10:05 AM by Andrew Walter May
Changes in home appraisals can cost you tens of thousands of dollars
Appraisals are the life-blood of the mortgage industry, and the first place to start when thinking about refinancing or purchasing a home. Without an appraisal, you can’t get a purchase-mortgage (the Federal Government through Harp 2.0 allows, in certain instances, no appraisal on refinances).
To illustrate how appraisals can save or cost you tens of thousands of dollars, we take you to the Pinehurst NC market. In fact, let’s go bigger than that and take the entire County where Pinehurst resides, Moore County, and evaluate the effect of one appraisal on the housing market.
Really, one appraisal? What effect does one appraisal have on a small market like Moore County (NC)? After-all Moore County has slightly less than 100 sales a month (through September 2012 about 750 homes were sold….). This one example will show you why it is vitally important to keep your wits about you when selling your home….or buying into a smaller market like Moore County (or coastal counties that have even fewer comps). (Warning: This example further illustrates the need for new beginnings in Federal Government housing policy making). Mortgage expert, Andy May, has written extensively on home price forecasting and was awarded the first mortgage related patent.
Ok, so you want to purchase a $300k+ home (but less than $400k). That means there are about 20 homes sold per month in Moore County (less in the low season, more in the summer), down from 100 per year over-all. If your price point is in the $25k range then you’ve got even fewer comps. So the time of year significantly effects your valuation.
In 2009 the federal government basically took full control of the appraisal industry (in 2009 the feds scrubbed the industry and added a new layer of “management”) – eliminating a competitive market place here for appraisers (no appraiser shopping, just a “rotary approach”). The first thing to remember is we now need 3 comps within the last 3 months, with most lenders also requiring a minimum of 2 current listings in order to get a marketable appraisal (no discount in value due to lack of market sales data). Andy May, the mortgage expert, has countless examples of appraisals good and bad.
So, in the example that I will use your buyer decides to find a problem with your home in the inspection process. While the appraisal came in 10% lower than you were expecting now you’ve got a buyer that has an inspector that finds a “water” or “other” problem with the home. This further reduces your value as it becomes a disclosure problem for you. Granted, there isn’t in fact a problem and you spend $5,000 proving it. But now you have to disclose to the next buyer (your findings and the current buyer’s “complaint” or documentation). You decide to bail and sell the home for $250k (you originally listed it at $350k – but dropped to $299k and so on….). You are out of the market and have sold your home for $250k ($100k less than what you were expecting). What about the next 3 months of comparables for future buyers? Yes, your home that you sold on the cheap comes up and represents a major comparable (comp) for your neighbors. Or does it?
The high and low comps are tossed out, so no worries here. We’ll just toss out this low comp and go with the next lowest comp …..unless this happens twice within 3 months (that’s a very distinct possibility). Now, homes start to depreciate rapidly as a result of two bad appraisals. This is what happens in smaller markets. How often? Even once is too much.
The effects from this situation are felt throughout the community. Mathematically, homes in smaller markets will continue to decrease in price due to the 2009 Federal Government housing policy on appraisals. Smaller market home prices are capped from going up – as only a cash buyer can likely pay more than the appraisal or purchase price (which-ever is lower).
In smaller markets where there aren’t enough comparables, chances are that you can’t get a loan in that community. Since the number of homes that have sold is minimal, lenders will not take a dated comparable (a comparable that is over the 3 months, 6 months, over even a year). These communities will continue to fall into decline and values will continue to erode.
So, resale of your property is highly dependent on the number of sales in your community. Be a smart consumer and don’t purchase where monthly sales volume is below 100 a month for your price range ($300-$400k in this scenario). Stay away until the federal government changes this poor housing policy. There will be some great deals, and always will be, until the feds change the appraisal policy. Until then – stay on the sidelines and rent in these smaller communities. You can always purchase when the policy changes. The unintended consequence of this housing policy is to encourage people to live and work in larger cities.
So, how can the consumer benefit from understanding the appraisal process? First, we’ll need to examine the way appraisals used to be done prior to Andrew Cuomo’s backing of the new appraisal process . The prior process used to take 24-96 hours to complete an appraisal (at a $350 cost). Lenders were allowed to communicate with appraisers and appraisers that didn’t meet the expectations of the lender had two ways they could handle the appraisal. The first was to make the number no matter what, and the second was to be professional and do the right thing.
Enter the federal government (2009), with the support of much lobbying by the big banks and special interest groups. Obviously, the federal government needed someone to blame, and the appraisers looked ripe. Forget about the 100% No-Doc Investor loans, the negative amortizing loans, the pick-a-payment option, the interest only loan, or the myriad disaster loan programs that lenders offered. And of course forget about the money trail (banks and the feds through Fannie and Freddie paid million dollar paydays to executives). The feds thought it best to blame asset values rather than fraud or bad loan programs. And thus was created, the new (and seriously flawed) appraisal system; which takes 1 to 3 weeks to complete (at a $425 or so cost).
“System” is an under-statement, but it now works like this: Lenders can-not legally speak with appraisers. The appraiser works for the vendor management company. The vendor management company just acts as a go between for the lender and appraiser. The originator is not allowed to speak with the appraiser, in fact if they do the appraisal becomes null and void and the consumer is responsible for the additional cost for another appraiser. In this regard, the vendor management company takes their fee first and then the appraiser makes a minimum of 25% less than what they did five years ago for twice the work (appraisers actually made more money per appraisal in the 1980s then they do today). Out of business went all the independent appraisers. In came big business, bank holding companies, and a whole new layer of cost. The appraisal in a nutshell is now ordered randomly and the appraiser gets paid no matter what (regardless of service level or skill). In some cases, the appraiser doesn’t even have to complete the appraisal in order to charge the consumer (since the appraisal management company gets paid just for registering the order).
So looking back at the previous few statements – there is another hand in the kitty, the lender wants more work to be provided, and you have a frustrated appraiser making less money. Do you think that the appraiser is going to go the extra mile? Now there are solid appraisers out there that do take their job and license seriously, and if they accept an appraisal assignment, they accept it knowing what they are being paid. Which appraiser will you get?
With no repercussions for a low appraisal, and only legal risk for a high appraisal, many appraisers are simply low-balling appraisals. There are no repercussions for a low appraisal. In fact, the appraisal industry gets more appraisals when low appraisals are submitted (since the refinance consumer may get more appraisals before they get the number they want). Appraisers still get paid. If there is a complaint regarding an appraisal, it has to be based on methodology and not value. As a consumer, how would one know the ins and outs of an appraisal? Even after the appraisal report is received by the consumer, the appraiser cannot discuss the value.
So, with that as the back drop – what does it mean to me (the consumer)? Well, for one thing, you’ll want to make sure the appraiser doesn’t have a lot of complaints ….although there is no complaint system in place to check. You have to vet that appraiser when you speak with them over the phone. Are they fully licensed? How long have they been appraising? How long as a fully licensed appraiser? It can take up to five years to gain your appraisal license, serving as an apprentice until fully licensed. This is another reason to have a fiduciary (licensed loan officer) by your side. Banks and credit unions are not required to hire licensed loan officers (although many get registered, meaning they supply their name to the registration system). Still, 18 (years old) is the required minimum to sell mortgage loans at a bank or credit union. Who will you choose as your mortgage expert?
Get the most value out of your home sale or purchase by working with licensed professionals that have significant experience. You’ll be thankful you worked with a licensed professional.