Everyone talks about appraisals, but few consumers seem to completely grasp the concept.
That’s understandable, but with mortgage approvals dependent on appraisals, ignorance is not bliss.
Appraisals are used to determine the market value of the house you are going to buy. The market value is the figure on which the mortgage lender bases the decision about the amount you can safely handle.
Although a relatively important matter, discussions of appraisals merit only a paragraph or two in most real estate self-help books published for consumers.
“The chief confusion for consumers these days is that many believe an appraisal and a home inspection are the same thing,” said Chris Artur, broker/owner of Artur Real Estate in Philadelphia.
“When a buyer pays for an appraisal, he is paying to protect the lender’s investment. When a buyer pays for a home inspection, he is protecting his investment,” Artur said.
The appraiser’s job, therefore, is to determine market value, not whether the furnace works.
Most residential appraisals clear the hurdles without a problem. Many are so routine, or the value of comparable properties in a neighborhood so well-known, that the appraiser only finds it necessary to drive by the house or perform a cursory inspection by walking around the property or spending some time indoors, just to guarantee that there are no surprises at settlement.
Others, including Eileen Dodsworth, a broker-appraiser with Weichert Realtors in West Chester, Pa., pay strict attention to the appraisal forms required by Fannie Mae and Freddie Mac, which repackage home loans for the mortgage-backed securities markets.
These forms require a “narrative appraisal,” Dodsworth said–information on such topics as topography, number of rooms, condition of basement walls, and whether or not the house has “adequate floor plan and traffic-flow pattern.”
Dodsworth has been doing appraisals since 1960.
Narrative appraisals are required for estate sales and property settlements such as divorces, Dodsworth said. While the typical bank appraisal involves setting market value alone, property settlement appraisals involve an income approach (what it would rent for) and a cost approach (what it would cost per square foot to replace).
“All the approaches have to agree with one another,” Dodsworth said.
On average, Dodsworth spends a half-hour on an appraisal, using an electronic device to measure the interior square footage, a measuring tape to determine exterior square footage and “lots of photographs, so what I see will remain fresh in my mind.”
Careful appraisals will include photographs of the property as well as photos of at least three comparables–recently sold properties–within a reasonable distance of the house for sale, she said.
Sometimes, the comparable properties can be found in the same neighborhood–“cookie-cutter houses.” Often, however, especially in a slow real estate market with few recent transactions, an appraiser will have to search for such comparable data, Dodsworth said.
The comparable sales the appraisers use are either recent or ones that occurred under market conditions similar to those existing when the subject property was being appraised.
This allows the sales data presented to the lender to be the best available, offering good indicators of the property’s market value.
Whether it is done with a fine-tooth comb or simply a drive-by, a typical residential appraisal costs the buyer $250 to $300. However, as Dodsworth points out, the appraiser gets anywhere from $50 to $150 for his or her work.
The market value of a property seems easier to determine when prices are falling, Artur believes, which is one reason so few residential appraisals are disputed.
“In a market in which prices are falling, appraisers can easily prove that the value of a property has fallen, because there are enough comparable sales to prove it,” Artur said.
“In a market in which prices are increasing, such as during the real estate boom when multiple bids drove up prices, it wasn’t as easy, because the increases depended more on demand for a particular house than the market in general,” according to Artur.
Unless the price a seller is asking is outlandish, “the value of any property is in the eye of the beholder,” Artur said.
“Most appraisers I’ve dealt with over the years believe that the market value of any residential property is what the buyer will pay and what the seller will sell for.”
Still, in this age of consumerism, buyers and sellers are requesting explanations.
One trend that likely will have a wide-ranging effect on the appraisal industry is streamlined lending–the ability to complete a transaction by computer and without the reams of paper that have traditionally clogged the mortgage process.
“I think it will make dinosaurs out of residential appraisals,” said Harvey W. Levin, chairman of the Pennsylvania Real Estate Commission and president of Keystone Appraisal Co., a Philadelphia firm that appraises industrial and commercial properties.
“Some lenders are looking at credit being more important collateral to secure a loan, and that can be a signal for disaster,” he said.
Instead of requiring a thorough appraisal, many lenders are simply looking at a census tract, reviewing the prices of the last five or six sales there, hiring an appraiser to do a drive-by and then approving the loan.
“In residential refinancings, some lenders are talking about lending money at loan-to-value ratios of 125 percent based on this kind of appraisal,” Levin said. “This is something that would never be allowed in commercial or industrial appraisals, not after the savings-and-loan debacle of the 1980s.”
The danger, Levin said, is there is always someone who will try to beat the system.
“The appraiser will do a drive-by and assume that the interior looks as nice as the exterior,” Levin said. “What would prevent a seller from hiring the best exterior painter in the area to make the outside look beautiful, even if the inside was a disaster?”
Fred Glick, president of Heart Mortgage in Philadelphia, said most lenders discourage drive-bys for primary mortgages but ease up a bit on second mortgages and commercial loans.
But the overall value of the appraisal to the loan depends on the loan-to-value ratio, he said.
“If the loan-to-value ratio is 50 percent, a lender is not as likely to be concerned by the appraisal as by the borrower’s credit,” Glick said. “That’s a no-brainer.
“But with a high-to-loan value ratio–like 95 percent–a full appraisal is necessary,” he said. “If a borrower goes into default with a 95 percent loan, Fannie Mae and Freddie Mac already are losing money, because they have to hire lawyers, go into foreclosure, and resell the house.”
The 125 percent loan-to-value loans “might as well just be called `credit cards,”‘ Glick said. “Of course the lender wants to see appraisals, but these loans are only being given to borrowers who are considered good credit risks. So, basically, they are unsecured loans.”
Few appraisals vary much from the asking price because most appraisers get to see the agreement of sale before they make the appraisal, he said.
This appears to be the case even with government-backed Federal Housing Administration and Veterans Administration loans, in which the appraisal requirements are generally stricter than in the private sector.
Often, however, FHA and VA appraisals can be subject to the whims of appraisers, who might use their own standards to enforce federal regulations–such as lead-paint removal–and can demand that a seller remedy certain flaws before a mortgage can be approved.
Both FHA and VA appraisals have an appeals process, however. And even if an appraisal is reduced, there is a slim chance that the appraisal can be changed upward.
Because FHA appraisals often contain some of the elements of a home inspection, buyers sometimes use the appraisals in lieu of the kinds of inspections being purchased by about 80 percent of home buyers who obtain conventional mortgages.
Documented abuses of the appraisal system led the federal Department of Housing and Urban Development this summer to toughen its standards, requiring a more thorough basic survey of the physical condition of the home to uncover potential problems and disclose any defects to prospective buyers.
Some FHA appraisers complained that the tougher standards would, in effect, turn appraisers into home inspectors as well.
“It is unfair,” said Dodsworth, who has heard complaints from FHA appraisers. “They are getting paid to do one job, not two.”
Recently, however, a bill was introduced in the U.S. House requiring separate home inspections for all properties purchased under the FHA program, with a three-day window to bail out of the deal. The bill, if passed by Congress, would serve to effectively separate inspections and appraisals.
Although they dread the costs involved in foreclosure, Fannie Mae and Freddie Mac are making greater use of automated property valuations–using computer models to make appraisals–to save time and money.
“Computerization makes administration of underwriting much faster,” said Peter G. Miller, author of several books on home financing. “You don’t have to re-enter information because once it’s there, it’s easily retrievable.”
Fannie Mae requires a licensed appraisal for all mortgage transactions. Its automated system–the Desktop Underwriter–processes more than 14,000 transactions each day, according to David Voth, vice president for credit policy.
Loan Prospector, the automated system used by Freddie Mac, can return an evaluation of a loan application in two minutes, according to spokeswoman Kimberly Stein.
“The software is getting more sophisticated with the addition of hundreds of thousands of transactions,” Stein said. “This transaction modeling allows us to understand the risks better so we can make the decision faster.”
The appraisal process can gum up the works, but Loan Prospector has been able to reduce the time by 30 to 40 percent using a process that allows loans that have met a variety of criteria “to go to the front of the line,” Stein said.
The appraiser is required simply to check out the house “to make sure it exists and there isn’t a train track running through the front yard,” Stein said.
