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By RUTH SIMON
Staff Reporter of The Wall Street Journal
With home prices climbing at a double-digit pace in many parts of the
country, lenders are increasingly worried about inflated appraisal values --
and some are taking steps to clamp down.
U.S. Bank Home Mortgage, a unit of U.S. Bancorp, has increased the number of
in-house appraisers on its staff roughly 40% in the past 18 months --
cutting down its reliance on outside appraisers. The Minneapolis lender also
is doing more audits of appraisals produced by outside firms, particularly
in areas where home prices have been climbing rapidly.
Some lenders are getting pickier about the appraisers they do business
with -- a policy that is easier to enforce now that refinance activity has
slowed. At IndyMac Bancorp Inc., the pace at which new names are added to
the lender's "exclusionary" list of overly aggressive appraisers has
increased fourfold in the past year, says Executive Vice President Frank
Sillman.
Some lenders also are turning to computerized models in an effort to weed
out inflated valuations. National City Mortgage, a unit of National City
Corp., last year rolled out an automated system designed to flag the 5% to
10% of appraisals that need additional review. IndyMac added an automated
system last year as well. Washington Mutual Inc. says it is testing new
tools that would provide "automated, independent information about a home's
value."
Federal banking regulators also are looking more closely at how lenders are
managing the appraisal process out of concern that it is one factor in the
overheated real-estate market.
The fluid nature of appraisals has long been an open secret in the
real-estate world. Now, the fast-moving housing market has increased worries
that inflated appraisals could lead to problems.
There are fears overly generous appraisals will add fuel to a speculative
housing market by feeding expectations that prices will continue to rise
rapidly.
Such fears come on top of concerns about mortgage fraud, reports of which
have soared in recent years, according to the Federal Bureau of
Investigation. In some mortgage frauds, appraisers act in collusion with
borrowers to provide misleading valuations, the FBI says. In others,
properties are falsely appraised at a higher value and then quickly sold.
Appraisals are designed to protect lenders and homeowners alike from
overextending themselves when taking out a home loan. When the appraisals
are inflated, borrowers can wind up owing more than their home's value, even
if prices do not fall. Lenders also can be left holding the bag if the loan
is not repaid. The risks are heightened when borrowers are taking out loans
for most, or all, of the purchase price, as is often the case today.
Coming up with accurate valuations can be particularly tricky in hot markets
where home prices can jump by tens of thousands of dollars in a matter of
months. "We find it more difficult to find comparable properties" -- a key
tool in setting a valuation -- says Rob Snow, head of retail lending at
E*Trade Financial Corp. "If each property on the block sells for $50,000
more, it's very hard to get an accurate value." E*Trade has been
scrutinizing appraisals more closely since it launched a unit that focuses
on loan-closing services last year.
Of course, plenty of lenders and appraisers adhere to good practices. Still,
appraisers say they are sometimes pressured to increase valuations, directly
or indirectly, by mortgage brokers, loan officers and real-estate agents,
who all are eager to make sure a deal is completed. About 55% of appraisers
say they have felt pressure to overstate the value or condition of a
property, according to a 2003 survey by October Research Corp., a provider
of news and information to the real-estate-services industry.
Fear of Losing Business
Unlike mortgage brokers or real-estate agents, appraisers are paid whether
or not the deal is done. But appraisers fear that they will lose business or
won't be paid if they state a property's true value.
The Appraisal Institute is pushing for legislation that would prohibit
inappropriate pressure on appraisers. "The issue of appraiser independence
is the No. 1 issue we hear about from our members," says Bill Garber, the
group's director of government affairs.
In a fast-moving market, even buyers can be eager to get an appraisal that
matches the purchase price, so the deal can close.
Typically, appraisals are paid for by the borrower, usually as part of the
loan-application process. Under federal rules, the borrower doesn't get to
pick the appraiser. The lender can pick the appraiser, but to protect
against conflicts, federal rules say the person commissioning the appraisal
shouldn't also be making the final loan decision. In practice, the actual
choice can be influenced by the mortgage broker, loan officer, or
real-estate agent.
'Watching for a While'
Many of the nation's leading mortgage lenders are focusing more closely on
their appraisal practices. Bank of America Corp., this month posted a notice
for its mortgage lending staff highlighting the issue of inflated appraisals
and how the bank works to protect against them. "It's something we've been
watching for a while," a Bank of America spokeswoman says.
In some cases, lenders are requiring a second opinion. Tom Freeze, an
appraiser in Newport News, Va., says lenders have begun asking for two
appraisals on properties valued at more than $1 million and on purchases by
buyers with less-than-stellar credit scores.
Investors who buy mortgage-backed securities also are paying attention. "We
just assume that appraisals are a little lofty, and do not believe there's as
much value in the house as we're being told there is," says Scott Simon, a
managing director with Pimco, a Newport Beach, Calif., asset-management
firm. In part because it fears appraisals are too high, Pimco is demanding
deals be structured to give it more protection against potential losses.
Greed Mode
Part of the problem is inflated expectations. "Buyers are still in a state
of panic and sellers are still in the greed mode," says Sara Schwarzentraub,
president of Inter-State Appraisal Service near San Diego, Calif. "There are
a higher percentage of [deals] where we think the numbers are unrealistic."
That means more of the appraisals her firm provides are coming in with
values that are lower than borrowers expect. That is now happening on two to
three out of every 20 properties, she says, up from one out of 20 a year
ago.
In some cases, borrowers are overestimating the value of properties.
Ditech.com, a unit of General Motors Corp., says that about 20% of its
appraisals came in below the borrower's estimate in the first quarter, up
from about 12% last year. "Some people are basing their expectations on the
appreciation they've seen in the previous five years," says Ditech.com
General Manager Mike McCarthy. Few transactions fall apart because an
appraisal comes in below the expected value, but borrowers may be forced to
come up with more cash for a purchase (or reduce the amount of money they
get in a cash-out refinancing). At Ditech.com, the purchase price is reduced
on about 10% of the cases where the appraised value is lower than expected.
To protect against bad appraisals, homeowners should request that the bank
uses a "designated" appraiser and not simply one who meets state licensing
standards, says Alan Hummel, past president of the Appraisal Institute, a
trade group that confers such designations, who this week testified before
Congress on pressures appraisers face.
In guidance issued in March, federal banking regulators said loan officers
and others who stand to profit from loan volume shouldn't order appraisals.
The guidelines also indicate that lenders should review each appraisal to
ensure that the appraisal was independent. While the guidelines do not add
any new requirements, "we are looking more closely at how banks are managing
their appraisal process," says Barbara Grunkemeyer, deputy comptroller for
credit risk at the Office of the Comptroller of the Currency.
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Lenders Clamp Down On Inflated Appraisals
