What is a home worth? The classic definition of fair market value is the price a property would sell for on the open market, as agreed upon between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts. But anyone who has contracted to buy or sell a home and then had to wait for the judgment of an appraiser knows who has the last word with respect to real estate valuations.
In the wake of the recent mortgage market turmoil, there is an appraisal revolution now going on. Part of the revolution will be institutionalized broadly, the result of settlement of a lawsuit filed by the New York Attorney General over appraisal practices. Fannie Mae and Freddie Mac have signed on to the agreement, along with their government overseer.
Home appraisers have been criticized for having facilitated the escalation of the conforming limit, which is the maximum that qualifies for purchase by Fannie Mae and Freddie Mac, remains at $417,000 for much of the country, but also rises, to as much as $729,750 in high-cost areas.
For conforming loans, there is a more expansive determination of “high cost.” The rules for conforming loans are benchmarked to 125% of the median home price for the highest priced county in a metropolitan area or, in the case of a rural area, 125% of that county’s median home price. Legislation in Congress would increase the conforming limit even more, fixing it at $625,000 and 125% of the median sales price in high-cost areas.
However, the measure is stalled in a conference committee after having passed the House and Senate and its home prices in recent years by being influenced by the sales price of the home being appraised and finding ways to justify “hitting the number,” so that the loan approval would go through unscathed. Failure to do so sometimes meant that an appraiser would fall out of favor with lenders looking to make deals, not torpedo them. At least one appraiser has filed suit, alleging that she was de-listed for not providing favorable appraisals.
Historically, reliable appraisals were appreciated by purchasers who recognized that a good appraisal was a backstop that prevented them from overpaying for a home. However, more recently, low appraisals were more likely to anger, not just sellers, but also buyers, who saw their plans derailed after having spent weeks or months in the search for a home and their financing plans disrupted.
In fairness to appraisers, determining value in a rapidly appreciating market is tricky. How do you judge what a home is worth when there are multiple buyers willing to pay prices higher than previously seen in a particular neighborhood? In such cases, comparable sales don’t tell the whole story.
Don’t buyers and sellers, rather than disinterested outside parties, by definition, ultimately determine value? In any event, understand that the climate had been changing even before the recent settlement was announced.
Conservative appraisals are becoming the new industry standard.
For instance, foreclosures, once viewed as unrepresentative transactions that have little bearing on the essential value of homes in a neighborhood, are now being given full consideration, even establishing a market’s value in some cases. And appraisers selected by local mortgage professionals are being replaced by appraisers approved by lender/investors.
The voluntary trend is more important in the short term because the lawsuit settlement doesn’t officially take effect until January 1, 2009 and applies only to lenders doing business with Fannie and Freddie.
However, many parts of the settlement are likely to be implemented earlier and more widely than with just Fannie and Freddie’s lenders. The settlement agreement provides new safeguards intended to ensure appraisal independence and more reliable valuations. The aims are both to provide consumers with the best information to consider in determining their financial interest, and to help restore confidence in valuations of mortgage pools, which is crucial to maintaining the supply of mortgage credit. Key to the agreement is establishment of a Home Valuation Code of Conduct that prohibits certain practices intended to improperly influence appraisals. Among the practices specifically prohibited are telling an appraiser what value needs to be established in order for the proposed financing arrangement to go through. However, a lender can give the appraiser a copy of the sales contract, so that information could still be available if the contract spells it out, at least for purchases.
Lenders can ask the appraiser for additional information or explanation about the basis for a valuation and can point out and correct any factual errors in an appraisal report. The agreement also establishes a Valuation Protection Institute that will monitor appraisals and to which consumer and lender complaints about appraisers will be sent for investigation. An appraiser who feels that their independence has been threatened can also contact the Institute.
© 2008, Real Estate Information Services, Capitol Assets, Choice Real Estate, Inc. & Choice Real Estate of VA, Inc., & Choice Finance®
Brent Mendelson
