Navigating through appraisals and mortgage lending

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Residential mortgage lending is a collateral-based business. When a borrower applies for a mortgage, whether to purchase or refinance a house, the lender – or investor – evaluates the borrower’s ability to pay back the loan by reviewing income and credit.

Simultaneously, the investor, by federal mandate, requires an objective third party to assess the property’s market value. The security for the mortgage is the property itself. Should the borrower fail to pay the mortgage, the lender takes the property. That lender wants as much assurance as possible that the property is worth the value they based the loan upon.

When one applies for a residential mortgage, an appraiser will be assigned the task of producing a standardized report or appraisal to evaluate “market value.” In most cases, the borrower pays for the appraisal. However, the appraiser works for the lender.

Years ago, in an effort to demystify this process, I asked an old friend, an expert Taos appraiser, to help explain the nature of the report, the methodology and the appraiser’s relationship to the transaction and the principals. Ed was most knowledgeable about Taos County and surrounding areas and served on the national board of directors for the Appraisal Institute (AI) as vice chair of Region 8, which includes Texas and New Mexico. He also served on the National Finance Committee of Appraisers.

Appraisers are not deal facilitators,” Ed explained. “We are not advocates. We are observers, the trained eyes and ears of the lender.”

Appraisers are local experts who utilize both standardized objective measurements and characteristics along with their expertise of the nuances of their community to compare the subject to other properties that have sold within a reasonable distance and time of the subject.

Ed referred to this comparison of like properties as “the principle of reasonable substitution.” An appraiser finds at least three similar properties that have sold, ideally in the last 90 to 180 days, and based on comparison concludes that if these homes sold for X, Y and Z amounts, it’s reasonable to assume the subject would sell for a similar price in this same marketplace.

Many of the standards used for comparison are objective. Square footage, room count, garage and fireplaces are examples, but as Ed noted, “Many of the variables are subjective, especially with regard to the condition and physical depreciation of the home. This is where local expertise is essential, knowing what is typical of an old adobe or expected from an Earthship. The subjective decisions of an appraiser can influence value by as much as 20 percent.”

As a mortgage broker, I’ve often had buying clients ask me why the appraiser receives a copy of the purchase agreement when preparing an appraisal. Their concern is that if the appraiser knows the contract price for the home, the buyer is not getting a truly “blind appraisal.” The suspicion is that the appraiser knows the price and meets it to make the deal.

The appraiser must receive the purchase agreement according to federal law.” Ed said this is because, “We need to know if the seller is paying any concessions, if private property – such as artwork, furniture or a car – is included in the deal or if there are any unusual terms or conditions.”

He went on, “We don’t know the value of the house, only the agreed-upon purchase price when we receive the purchase agreement. We’re hired to use the available sales data from the community to then establish value for the lender.”

When asked what the biggest challenges are for an appraiser in this market, Ed had two answers.

First, there is not enough sales data to reliably find strong comparable sales. There were around 275 to 300 residential home sales during some big years in this market. During leaner years, there might be about 170 to 200. As the numbers shrink, the numbers of sales in each price strata are reduced, giving the appraiser less data to work with.”

This problem is exacerbated in a market like Taos, as we don’t have tract homes reproduced throughout the county. We do have idiosyncratic homes that reflect the independent nature of our citizens and region. This only makes the appraiser’s job more challenging.

The other issue that impacts appraisals is the number of foreclosures in our area and how they affect values. When there are numerous bank sales, those “distressed sales” impact the appraisals in this small community.

Ed had explained that if a foreclosed property sells within 90 days of being put on the market, it can be considered a sale “under duress” and the price can be adjusted accordingly. “But if that property is on the market for more than 90 days, it becomes more like any ‘arms length transaction’ and the market is both impacting and being impacted by that sale.” In short terms, according to Ed, “That many foreclosures has to affect the market value of homes throughout the area.”

While mortgage lending is a collateral-based business, appraisals have been both more difficult to complete and equally difficult to assess. It’s not uncommon for two appraisers to value a home quite differently. We have seen 25 to 30 percent disagreements on the value of a home based on two different appraisers turning in reports on the same property within 30 to 60 days of each other, though such disparity is untypical. This is often the result of the subjective decisions made by appraisers, as described above.

It makes it difficult to reliably determine value, although the industry has no better way of approaching home values than what is currently in place. There has been great effort over the past years to correct and improve the reliability of appraisals. One result of the Dodd-Frank Wall Street Reform and Consumer Protection Act was to create a “firewall” between lenders and appraisers so that there is no – or at least reduced – potential for collusion between them to impact values. Appraisals are also scrutinized more carefully by lenders, and it’s not unusual for a lender to request additional comp sales from the appraiser in an effort to further substantiate value.

Establishing the value of anything is difficult because much is subjective. What’s the value of a painting by Monet, a day on the beach, a handwritten score by Duke Ellington or a smile from a handsome man across the room? I suppose it depends. Regardless, the appraised value of a property is the most complicated and important piece of data collected by a lender in determining the acceptability, scope and nature of a loan. Vanessa Dimond has lived in Taos NM since 1989 and been in the mortgage business in Taos since 1994. Vanessa and her husband, Ted, opened Dimond Mortgage in 2003. Vanessa can be reached at vanessa@dimondmortgage.com.

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