Taming inflated home appraisals
New guidelines aim to reduce the pressure that real estate appraisers feel to boost home values.
NEW YORK (CNNMoney.com) -- Washington policy makers have taken aim at one of the main contributing causes to the housing crisis: inflated appraisals.
When home prices were soaring, one of the driving factors was that appraisers, pressured by loan officers and mortgage brokers, kept hyping home values. Not only did homebuyers wind up paying more, but the exotic mortgage products they needed to finance their purchases later exploded, setting off the financial and economic turmoil the nation is facing today.
Now, the Federal Housing Finance Agency (FHFA), the government agency created to oversee Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500), has announced a plan to curb the influence that loan originators exert on appraisers to overvalue homes. A new Home Valuation Code of Conduct, which will take effect this May, is an attempt to improve the reliability of appraisals for mortgages sold to the two companies. The guidelines prohibit lenders from coercing, extorting, colluding with, intimidating or bribing appraisers into making inaccurate appraisals.
"It's a step in the right direction," said Tom Inserra, president of Pinnacle Peak Appraisers in Arizona, who has testified before Congress on appraisal issues. "Separating the lending function from the selling function had to be done."
Fannie and Freddie have a strong interest in ensuring the soundness of appraisal reports because they're the basis for the mortgage loans that they buy from lenders, according to James Lockhart, FHFA's director.
Most mortgages in the United States are now bought by Fannie and Freddie, who then securtitize them and resell them to investors.
Appraisals get inflated because the incomes of mortgage brokers and loan officers depend on how many mortgage loans are approved. A high appraisal ensures that the house - the collateral backing the loan - is worth more than the amount of the loan, which reduce the bank's risk.
Inserra knows how intense the pressure to inflate values can get. Three years ago, he found himself battling one of his largest clients. The bank's senior vice president in charge of mortgage lending tried to get Inserra to "hit a number," industry parlance for inflating the appraisal. He wouldn't do it.
"The discussion got so heated," recalled Inserra, "that he threatened to do harm to my family if I didn't co-operate. I really thought he might do it. I got a restraining order from a judge."
In the end, the banker didn't hurt his family, but he did punish Inserra by depriving him of the $200,000 in annual business he had been getting from the bank.
That may be an extreme case, but it was not isolated. A 2007 survey by October Research found that 90% of appraisers said that they felt pressured to fudge figures.
Not everyone is convinced that the new guidelines will help.
"I'm very skeptical," said Elizabeth Kern, a past president of the National Association of Independent Fee Appraisers (NAIFA). "I think the only thing that will change is that we'll see the better appraisers, the more experienced ones, not getting the work."
Inserra wonders about enforcement of the rules.
"The concern is that, unless there's an enforcement mechanism that works better than what we have today, it won't do much good," he said.
Under the new rules, complaints from appraisers, consumers, or anyone else will be fielded by the "Independent Valuation Protection Institute," which FHFA will set up.
If a lender logs too many complaints, it may be prohibited from selling its loans to Fannie and Freddie. That should be enough to make lenders police their appraisals more carefully, since the government entities are virtually the only buyers left standing.
The National Association of Mortgage Brokers is not happy with the plan. According to its president Mark Savitt, mortgage brokers often work closely with appraisers to make sure applications are error free and accurate. That kind of co-operation may be construed as crossing over the line into trying to influence appraisals, even when it's not.
Savitt said increased enforcement of existing regulations is all that's needed to make the appraisal inflation problem disappear. "Beef up the penalties for the laws that we already have and enforce those laws."
Right now, few loan originators are held to account for pressuring appraisers. Bill Garber, director of government and external relations at the Appraisal Institute, reports that only about 15 states have any laws targeting loan officers and mortgage brokers, and these are not often enforced.
Appraisers themselves are more likely to get hit; more than 250 lost their licenses last year for hyping values, he said.
But if the new regulations help prevent some of the abuses, it could have a healthy impact on the housing market.