Appraisals, Appraisal Reviews and the New World Order of Closing a Deal

Several closed loans and many conversations with RE agents got me to thinking ( Thanks specifically to Ric Vega, http://ricvega.com/ and Don Bartley at Keller Williams Mid Willamette) about how most buyers have dealt with the issue of appraised value in a RE deal. In the past, borrowers of mine have followed the same pattern: 1, gets an offer accepted, 2, has "x" number of days to complete inspections, 3, negotiates any issue(s) that come up and then, 4, orders the appraisal. The logic was, why spend money on an appraisal if the deal was going to die because the house was a piece of crap. Appraisal gets done, value is at, above or just a wee under sales price...done, buyer has a new home.

Fast forward to 2009. Lenders are bashing on the one last thing that is available, the collateral. In order to be able to sell loans on the secondary market ( or even have the option to at a later time ) lenders must be able to say with more surety than ever that the loans they are doing will not go bad. The pressure on lenders to do their due diligence on a loan is more extreme than many may realize. This is nothing as obvious as qualifying a borrower on income, assets and credit history. Those restrictions, while frustrating to all those who participated in a deal facilitated by a stated income loan in the past, are going to be nothing compared to this. I would suggest we all come to grips really, really soon with the terms "Insufficient Collateral" or "Reduced Value".

Examples? Sure; a re finance client from another lender with 800 FICO scores, a 9% debt to income ratio and 85 months of payment reserves denied on a 50% loan to value transaction. This is what was known as a "make sense" deal. Not any more. A comment by the borrower was, " They wouldn't do a loan for me because they said they wouldn't be able to sell my property when they foreclosed on us. We are never going to miss payment!" A value reduced 15% by a review appraiser from the original value. Used 2 of the same comps but reduced the value of the subject by $5000 because it had a less superior view, both properties are in a residential neighborhood. Did the comp have a view of the neighbor ladies changing room? That could be construed as a superior view by some, but I don't know that it's worth 5 grand.

From my perspective we are seeing another manipulation of values. One that may do more harm than good. The first one, the restrictions on borrower credit, was in reality a very reasonable step to take. But now we are seeing the restriction of credit based on automated criteria in computer models for the valuation of a subject property. The use of Automated Valuation Models is the primary determinant if an appraised value will be subject to additional review. All by itself this has the potential to drive values even farther down than they would fall as a result of normal market forces. It's another vicious cycle that could kill a lot of deals late in the game. The issue will now be that sales transactions will be more likely to fail due to appraisal issues rather than inspection ones.

The reliance on AVMs is understandable, on the surface anyway. Taking the human element out of the valuation process removes any possibility of fraud or other nasty bad things that could happen. These systems are likely to be very robust in their analysis. After all, automated underwriting systems have made all approved loans non defaultable, right? But as with all computer models, garbage in, garbage out. In states where sales prices do not have to be recorded accurately ( or at all ) the quality of the information is at best suspect. Yet, lenders AND investors in mortgages rely on AVMs to quantify the risk associated with a particular property's value. I have argued, successfully and unsuccessfully against their use. For now, the battle continues.

My solution is to suggest the reversal in the order of inspection / appraisal regimen. The borrower should order the appraisal first, see if any value issues arise that may cause them to renegotiate or walk away from their contract, then order the inspection. After all, the appraiser will note any grossly obvious defects in the home that the inspection will no doubt flesh out. For the seller, well you guys are pretty well hosed right now, whether you think so or not. May as well get the really bad stuff out of the way early. Any seller that thinks they can dig their heals in on "their" price better take a look around and have their listing agent to give it to them straight. The first offer you get will be the best and highest one you will get, better take it and hope the borrower's lender doesn't come in and make your listing agent's CMA look like doody.