It Is Broken, So Fix It

By Charlie Elliott, Jr., MAI, SRA

 

Sometimes in the interest of accomplishing our current objectives we lose track of why functions of our business are set up the way they are. When it comes to real estate appraisals in the mortgage industry, perhaps we should go all the way back to the beginning and ask ourselves why we have appraisals in the first place. Who decided it would be a good idea to require appraisals on mortgage loans and why?

 

The concept of using appraisals of real property on transactions where it is used as collateral goes back, at least, to the stock market crash of 75 years ago and the Great Depression that followed. Many financial institutions failed during this dark period of our history, due to the fact that the real estate collateral was not enough for them to recoup the loss of defaulted loans. When that happened, those remaining in the business realized that it was necessary for lenders to more accurately determine the value of any potential collateral in order to insure that the collateral was sufficient to support the loans that they were making.

 

In those days things were a lot different. Most loans were made directly by the banks and thrift institutions and handled by their own staff.  For that matter, many of the appraisers were also on the staff. While managers of these institutions may have had financial incentives to make loans, it was not as prevalent as it is today. There was less room for questions about appraisals since there were few conflicts of interest in the overall program. Back then, the atmosphere was such that a borrower had to go into the bank with hat in hand and practically get down on his knees in order to obtain a loan.

 

Furthermore, there were fewer people with a direct financial interest at stake as far as whether the loan was made. If its loan officers did not see it as in the best interest of the institution to make a loan, it would not be made. There were few, if any other parties with a direct stake in the loan. Everyone knew that it was in their best interest for the institution to be protected, and most accepted the issue of appraisals and collateral.

 

Today, things are different in that most loan officers and appraisers financially are tied directly to each deal. Some lenders will say that the appraisal is a necessary evil and that it is the only link holding up progress in the process of making loans. I suppose that the same could be said about the regulatory process in any profession. 

 

Furthermore, the competition today is such that lenders are practically chasing borrowers in order to make loans. This makes the case for properly prepared appraisals even more important. It seems that many people involved in the process of ordering appraisals, reviewing appraisals, approving appraisals and approving loans have a vested interest that might be in conflict with getting a good, solid appraisal. It is not uncommon for appraisers to hear such comments as “We have to get the value of this appraisal up in order to make the deal,” or “These people may lose their home if the appraisal is not high enough for them to refinance,” or “This is the only deal I have going and I need to pay my rent this month.”

 

If you are questioning the ethics of some of these comments, you should. In my opinion, they border on being illegal, unethical and, perhaps, fraudulent. 

 

Perhaps, we need to review what an appraisal really is, what it is for, why we use it and how this relates to what is going on in the real world. Appraisals are for one purpose, and one purpose only. That purpose is to serve as an evaluation of the collateral that is being offered to make the loan and, in conjunction with that, to protect the interest of the financial institution making the loan. The Dictionary of Real Estate Appraisal defines an appraisal as “an opinion of value.” It also defines it as “the act or process of developing an opinion of value.” Would it have helped if the definitions had stated “honest opinion of value”?

 

Now, let’s talk about what an appraisal is not. It is not designed in any way to serve as a tool to insure that someone gets a paycheck. An appraisal is not designed as a tool to help enrich the employees of the financial institution to the detriment of the institution. It is not designed in any way as a tool to save someone from going bankrupt or to keep people from losing their home. Don’t get me wrong; none of us want to see people go broke or get foreclosed upon, but if an inaccurate appraisal is the only thing that can save them, earlier measures should have been taken, which represents a different problem.

 

To further demonstrate the problem, mortgage fraud and foreclosures are both at, or near, all-time highs. Appraisers complain about losing accounts because they are not willing to compromise their integrity and hit the number requested by those ordering the appraisal.

 

Having demonstrated the problem, it would only be fair to state that the majority of lenders ordering appraisals do not expect appraisers to participate in this kind of unprofessional conduct. The few rotten apples, however, are spoiling the whole barrel.

 

Who is to blame and who should fix the problem? While I will not condone such unethical and illegal conduct, and I believe that those guilty parties should pay for their deeds, merely punishing those involved will not solve the problem.

 

This problem has been allowed to exist by our government regulators. They, at a minimum, have control over it and a responsibility to correct it. Anyone with a rudimentary understanding of how the mortgage and appraisal business works must see that this system stinks to high heaven. There are so-called standards in place to prevent those, who are receiving financial incentives for selling loans, from ordering the appraisals on those loans. These rules are, quite simply, too loose and are not enforced.

 

Mr. Comptroller of the Currency and others in similar positions within the federal government, the system is broken and should be fixed. It permits the less scrupulous within our financial-services system to bleed off business from those who play by the rules and, in addition, causes billions of dollars to be lost annually from financial institutions and foreclosed loans.