President Obama inherited the worst financial crisis since Hoover and the Great Depression. It follows that getting the country back on track is no easy task and while his new housing plan includes much to support it also includes a provision to dump appraisals when they are most needed.
Dump is really the right word. Fannie Mae and Freddie Mac, says a White House fact sheet, “would be directed to use mark-to-market accounting or other alternatives to manual appraisals for any loans for which the loan-to-value cannot be determined with the GSE’s Automated Valuation Model. This will eliminate a significant barrier that will reduce cost and time for borrowers and lenders alike.”
This sounds great except that the goal of an appraisal is to protect not only borrowers and lenders, it’s also to protect mortgage investors such as pension funds and insurance companies — entities we want to attract or face far-higher interest rates.
The Need For Appraisals
It’s true that appraisals are a cost, but so are food, shoes and tires. The important point is not that appraisal are an expense, it’s that appraisals made by actual humans have value.
For some time there has been an effort to eliminate appraisers from the mortgage process with seers, soothsayers and automated processing. The pretext is that independent appraisals cost money and the computerized systems are pretty good.
Pretty good is an okay standard when you own thousands of loans, but residential borrowers typically have only one or two mortgages. To them, having a property accurately appraised is hugely important so they do not overpay whether they use conventional, FHA or VA financing. Indeed, most real estate sale agreements provide that the deal is off without penalty if the appraisal comes in below the sale price — speak with a buyer broker or attorney for specifics.
But not only home buyers are protected, with a good appraisal the lender does not lend more than it should (thus protecting shareholders) and a mortgage investor does not have excess risk (thus protecting pensions and insurance funds).
If you’re a buyer and make an offer on a property it will not get financed unless the appraiser says the home is worth at least the sale price. Without independent assurance from an appraiser — someone who is paid regardless of the valuation — no lender will provide the mortgage financing necessary to create the sale.
But it’s not just the buyer and the “lender” who are protected, if by “lender” we mean the folks who originate the loan.
Today after most loans are originated they are sold into the secondary market. Packagers gather up 5,000 or 10,000 loans and create a mortgage-backed security or MBS. Investors then purchase a portion of the MBS called a tranche.
One of the most basic protections for buyers, lenders and mortgage investors is an independent valuation of the property. The fact that a buyer and seller have agreed on a price does not mean they have accepted a price that will protect the investor if home values decline or the borrower defaults.
So, yes, let’s move ahead with new and better housing programs to reduce foreclosures and clean-up a system damaged by too many short-cuts. But while we’re at it, let’s not end a basic protection that makes the market safer for buyers, investors and mortgage insurers.