Bankers’ Hours column: The most misunderstood part of the mortgage lending process
Appraisals may be one of the most misunderstood elements in the mortgage lending process.
For one thing, there’s no such thing as an “accurate” appraisal when it comes to the valuation conclusion in the report. A real estate appraisal is an opinion of value, based on information that, if accurate, will make the opinion as meaningful as it can be.
Residential appraisals, those performed on single family residences and condos, have a short shelf life, because they’re based on market value. As we all know, that market is a volatile creature. So an appraisal in a rising market will be too low, behind current sales, because it’s based on recent comparable sales, reflecting prices lower than are currently being negotiated. The valuation conclusion will be outdated virtually the minute that the appraiser affixes a number.
The flip side is that an appraisal in a declining market will be too high, even though it’s done meticulously. Market prices for any commodity fluctuate, and real estate is no exception.
This should be kept in mind as one views the current disagreement between the appraisal business and federal banking regulators. Ironically, the same government agencies that mandated strict regulations, guidelines and time-consuming procedures for residential appraisals after the 2008 real estate collapse, are seeking to relax those same protocols to streamline the mortgage lending process. Appraisers are opposing them; just the opposite of the situation in, say, 2009.
The FDIC, Office of the Comptroller of the Currency (OCC), Federal Reserve and the National Credit Union Association (NCUA) want to raise the loan threshold at which an appraisal is required, from $250,000 to $400,000. The professional association for appraisers, the Appraisal Institute, says this is irresponsible and could be a factor leading to another housing crisis. (Not to mention that the number of appraisals that lenders order might decrease, as would appraisal fees.)
There are some interesting nuances to this. First is that any bank, operating within its own market, has a very secure handle on current real estate values. So, in the instance of residential real estate, an appraisal in the file doesn’t necessarily enhance the quality of the loan asset. Besides, when a bank or credit union makes a home loan without securing a third party appraisal, they’re required to do an internal evaluation of the collateral. In this process, the lender can do everything that an appraiser does, including physically inspecting the property. If these value assessments are cursory or careless, the bank will have its knuckles rapped by examiners.
It’s a different story if a lender is funding deals outside of its market, or is either buying or selling mortgage loan assets. To keep their loan portfolios as liquid as possible, banks will often paper files with third party appraisals; they’re documentation that the buyer will require. Virtually all residential mortgages will go into the secondary market, or are made with the possibility that they might. These deals are packaged into mortgage backed securities, and, by definition, must be thoroughly documented.
I know a small bank that wants to increase its earning assets and is using the appraisal waiver as a selling point. This is a good tactic, given their objective. However, if at some point the bank grows to a point where there’s a need to turn mortgage assets into liquidity by selling off loans, they might have to get a third party update of collateral values.
From a lender’s perspective, securing an appraisal is just an exercise in covering one’s posterior. The appraisal may not tell you anything about the loan that you didn’t already know, but if the deal goes south after it’s funded, it helps to have that third party valuation in the file to show to boss, examiner or federal prosecutor.
This is especially true with commercial real estate. Appraisals are important in papering a lender’s file, but often not much more than that, primarily because there are so many variables in the commercial appraisal process. In addition to the cost and market valuation determiners, there’s the income approach. A small variation in one of the key numbers selected by an appraiser, the Capitalization Rate, can result in sharply different value conclusions.
One of the gentlemen that I worked for when I was new the banking business, ran a small institution in the area where he’d spent all of his life as a businessman. He quite literally knew every property in his home town, and most of them within a 50-mile radius. He was criticized by the regulators for not having appraisals in the loan files. His response, “What do I need an appraisal for? I know what the house is worth.”
He was right, of course, but he still, not without effort, was forced into compliance. Sort of. He called me into his office after a few days on the job with the directive, “Do an appraisal on this deal.”
Which was a learning moment, since I’d never done one before.
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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