The Home Valuation Code of Conduct and the Great Appraisal Conspiracy

Why do we need appraisals?

An appraisal is an essential part of the home loan process. It is a requirement for all lenders on any real estate loan transaction for either purchases or refinancing. The purpose of an appraisal is to "approximate" the market value of a property at the time the money is borrowed. The appraisal is used to establish how much money can be lent on the property and to confirm that the property has enough value to act as collateral against the loan, as well as to prevent the fraudulent inflation of a property's value.

Fraud? What fraud?

During any period of lax credit standards there is going to be a percentage of people who are going to find or invent ways to manipulate the system to make dubious profits or commit outright fraud. There is and always will be a segment of any otherwise reputable industry that will engage in disreputable acts and thereby give the entire industry a bad name. There can be no doubt that disreputable mortgage brokers, appraisers, and real estate agents who, during the height of the real estate boom, were engaged in fraudulent activity that led in some part to the mortgage crisis, even though that activity represented a relatively small portion of the overall lending market.

The Intent of the Home Valuation Code of Conduct

It will probably take years to ferret out all of the causes and complexities of the credit crunch and mortgage crisis. I personally think that fraud perpetrated by individual mortgage brokers, appraisers or real estate agents will prove to be only a very small contributor to the global credit crunch. The intent of the Home Valuation Code of Conduct is to eliminate the possibility of fraud in the valuation of real estate for loans and perhaps accurately value real estate, especially now that most real estate has suffered some decline in value.

The Mortgage Crisis And The Valuation Process

Since the so called credit crunch or mortgage crisis began over two years ago, there have been many changes in the mortgage industry. One of the most significant ways if which the mortgage crisis has affected the loan consumer is in how their loans are processed. On May 1, 2009, the Home Valuation Code of Conduct (HVCC) bill that had been passed by Congress went in effect.

This new law is, supposedly, designed to put the appraisal valuation process in the hands of a disinterested party and thereby reduce the incidence of fraud and coercion in the appraisal processes.

To get a perspective on what changes are going into effect and how that is going to effect the consumer we need to look at the way the "old" system of ordering an appraisal worked.

As a mortgage broker, I am approached by clients who are interested in buying or refinancing a house. One of the steps in this process is to call up my favorite appraiser and ask them what value would be reasonable for the particular house in question. I do this before the loan processing has even begun to ensure that the house has the value needed to make the loan work.

This trusted appraiser, who I have worked with for years, is capable of delivering a quality report in a timely manner. They enhances the loan process by delivering a valuable product needed to process the loan. The reason that I use one of my "favorite" appraisers is that through the process of elimination borne out of years or experience I know who I can rely upon to do a timely, quality job.

Under the HVCC system my appraisal will now be "managed" by a so-called disinterested third-party appraisal management company, who by lottery, picks an appraiser out of a pool of appraisers in my area. The appraisal is assigned to this random appraiser, who I most likely do not know, with whom I cannot have any contact, and who may have any amount of experience, skill level or commitment to his or her job.

This added layer of so-called security is a direct reaction to the mortgage crisis and is an attempt by politicians and banks to assign some sweeping fix in an attempt to eliminate the possibility of fraud and other problems related the mortgage crisis.

Generally, I am all for processes that help deliver quality loans to consumers, but, the adding of yet another intermediary to the process has quickly proven to deliver just the opposite of it's intended effect.

The new HVCC system will add additional time and costs and a unique lack of accountability that will bog down the loan process — which is exactly the opposite of what is needed to get the housing market back on track.

An Ineffectual Model

For many years a similar lottery system was in place that may well prove to have been a model for the new HVCC system (I know that all of the loan officers and realtors will cringe when they read these words): the Veteran's Administration loan-appraisal process.

I am certain that the drafters of the bill used the VA appraisal process as their model for the new HVCC system, as the two systems are very similar.

Under the longstanding VA appraisal system, a VA-approved home appraiser is chosen at random and assigned a VA appraisal order that originated with the bank that would be processing the loan. In order to eliminate the possibility of coercion or fraud, the mortgage broker cannot know who the appraiser is, and the appraiser has up to three weeks to deliver the final appraisal. In the interim, the value that the appraiser will deliver is completely unknown. Mortgage brokers and realtors are then forces to wait for the appraiser to get around to delivering the appraisal, all the time biting their nails in hopes that the value will come in at a level that will actually support the loan application.

This is why VA loans are the scourge of the real estate world; because of the additional work and lengthy uncertainty created by the VA's processes, mortgage brokers and listing agents alike rank them among the least desirable of transactions.

Cracks In The System Have Already Begun To Appear

The HVCC system has already begun to prove itself to be slow and ineffective. These days, lenders are justifiably very conscious of the importance of obtaining a given property's accurate value, and will frequently require two appraisals or an appraisal review, in addition to the appraisal that a mortgage broker already orders through one of the so-called independent appraisal management companies.

That additional appraisal work is understandable now that housing values have been declining, and is just one of the additional steps that mortgage brokers and borrowers will have to deal with until values begin to recover. These new requirements are mostly being required when refinancing, but they are occasionally seen with purchases as well. It is these second appraisals and appraisal reviews are beginning to reveal the ineffectiveness of the HVCC system.

To fully understand why this new system will prove to be a stone around the neck of the recovery of the real estate market, we need to understand how the appraisal management companies choose there appraisers and how they assign the work to there chosen appraisers.

Firstly, we need to understand that the average self-employed appraiser used to charge around $400 to do a full appraisal, and that was part of the standard cost of closing a loan. Now that the appraisal management companies are managing the work, they have to pay their staff and much larger operating costs and presumably still make some degree of profit for their efforts.

So, these appraisal-management companies are adding $100 to the average appraisal fee, raising the overall costs of an appraisal to $500 but paying the appraiser only $200 (or less), keeping $300-plus of that fee that is paid by the borrower.

Most good appraisers have spent years building their businesses through experience, hard work and earned reputations, just like good mortgage brokers and good real-estate agents have done, and these long-time appraisers are rightfully upset that they now have to be forced into accepting half of what they used to make for doing the same amount of work.

Most of the good appraisers that I know have confided in me that they are protesting by rejecting all of the work the appraisal-management companies are sending to them. The result is that the appraisal-management companies are being forced to work with the least experienced, least-qualified appraisers who will work for the least amount of money — the bottom-of-the barrel appraisers.

If does not take a Harvard-educated MBA to deduce that the worst appraisers are very likely to produce an inferior product and be the slowest and be the least accountable. This, of course, has proven to be true, at least so far. My personal experience with this has shown that the second appraisals overseen by the appraisal-management companies have proven to be far inferior to the appraisals I ordered through the appraisers that I have done business with for years. In fact, some bank representative that I work with have told me that they are appalled by the lack of quality information contained in these new appraisals.

Under the old system, an appraisal could be completed in as little a three days if a real estate transaction called for a rapid turnaround. This rapidity is no longer possible under the new HVCC system, as the appraisal-management companies mandate a two- to three-week delivery time on all appraisal orders. It seems that most of those two or three week "processing" times are being taken up by the appraisal management companies' search for an appraiser who will work for a pittance so the management company can maximize its profits.

I feel that from the standpoint of the appraisal-management companies, the new system has become less about stemming fraud and producing quality products and more about squeezing more profit out of this newly-mandated system.

A Free-market System vs. A Controlled-market System

In a free-market system, the costs of products and services are dictated by forces such as completion, time and supply and demand. The marketplace sets the prices of goods and services and when a willing and informed buyer and seller come together and agree on the price of those goods or services. The purchase of real estate is no exception. When a seller lists a property for $400,000, then a buyer makes an offer of $380,000, and they eventually settle on a price of $390,000, that is the free market in action.

Under the new HVCC system, that free-market system could be replaced by a system in which an appraiser who is unknown to all of the parties involved in the transaction could potentially set the value of the house in a given transaction, with the potential of that price coming in far off the market value one way or the other. This is an extreme scenario but may not be far from the truth.

In our aforementioned free-market transaction, if the buyer and seller agree on a price of $390,000 but the low-budget "managed" appraiser decides that the value of the property is only $350,000, then there will be plenty of problems. All of a sudden the buyer and seller are not setting the value of the real estate, rather, our bottom-of-the barrel appraiser is setting the value, and setting it incorrectly based on lack of experience or care or some combination of both. Given enough of those sorts of errors we could see a definite dampening effect on the recovery of real estate prices.

What can be done?

If you have had trouble with the new HVCC system or you know of someone who has, or if you simply wish to express your concerns or complaints about the new valuation system, please contact your member of Congress via the link below: http://capwiz.com/namb/dbq/officials/

The National Association of Mortgage Brokers is quite actively working to overturn this bill. You may also send your HVCC "horror story" to the NAMB at: hvcc@namb.org

More information about the HVCC can be found by following the following links:

http://www.namb.org/namb/NewsBot.asp?MODE=VIEW&ID=257&SnID=992184185
http://www.appraisalinstitute.org/newsadvocacy/downloads/HVCC_myths.pdf

If you wish to pass along this article via the web. This article can be read at: www.mikethemoneyman.com/hvcc

About Mike the Money Man

Mike Carpenter, also known as Mike the Money Man, is one of Seattle's leading mortgage-industry and subject-matter experts. Staying true to his motto, "taking the mystery out of mortgages," he offers reliable and accurate information on today's credit crisis and the prevailing economic climate. Recognized for his competence and real-world experience, Mike is available to answer questions and counsel people who are uncertain and baffled by the existing financial market conditions. He is committed to sharing his knowledge and unmatched expertise with clients, educators, and the media.

For reprint permission, contract Mike Carpenter at (206) 465-5528 or via e-mail.