Over the past several years, we’ve seen homes sell for unheard of prices due to a shortage of inventory combined with historically low mortgage interest rates. This imbalance between supply and demand has driven up prices and forced buyers to aggressively compete for the few homes being offered for sale. This often means waiving all contingencies to improve the desirability of a purchase offer. Unfortunately this leaves prospective buyers in a precarious position in the event that the home appraisal doesn’t match the price offered.
Without a home appraisal contingency, the buyer may have to come up with additional cash to bridge the gap between what the mortgage bank will lend (based on the appraised value) and the offer price. To make matters worse, appraisers have been incredibly busy due to a high volume of home refinancing, putting the timing of the close of escrow at risk.
The net result of all of this is that getting a prompt and reliable appraisal is crucial for any buyer that isn’t offering all cash. Consequently it’s very important to understand how the appraisal process works and what you can do to avoid possible pitfalls.
The Role of Appraisals
Mortgage banks require that properties receive a certified home appraisal before a loan is offered to buyers. To reduce the risk of losing money, the banks want to make sure they don’t lend more than a certain percentage (typically 80% for a conforming loan) of the value of the property. If the borrower becomes insolvent or cannot otherwise repay the loan, the lender can foreclose on the loan and then sell the property to recoup their money. If the value of the property is less than the amount loaned, the bank will lose money (and banks aren’t generally in the business of losing money).
Following the 2008 financial crisis, which was largely the result of the sales of derivatives underpinned by mortgages that weren’t credit worthy, new legislation put stricter regulations on the relationship between lenders and appraisers. The Dodd-Frank Act was passed to create greater financial controls and consumer protections to avoid a future situation similar to what led to the 2008 crisis. The new guidelines are intended to ensure that home appraisals are accurate and realistic while preventing unscrupulous brokers from pressuring appraisers to provide higher valuations.
Appraisal Management Companies (AMCs)
This has led to the expansion of Appraisal Management Companies (AMCs) that act as intermediaries between lenders and appraisers to reduce the potential for conflicts of interest. Lenders now order property appraisals through an AMC who has a vetted list of licensed appraisers. The AMC assigns the job to one of their appraisers and the completed report is delivered back to the AMC who forwards the results to the appropriate lender.
While in theory this creates more protections for borrowers by reducing unscrupulous lending practices, it has some negative effects as well. Since many AMCs negotiate contracts with large, institutional lenders, home appraisal rates are set nationally and don’t account for regional differences in labor costs. This can lead to a situation where the AMC will only pay the local appraiser a rate which is much lower than the prevailing rate. The best appraisers choose not to work for these AMCs and instead affiliate with local lenders who better understand the local market and customs, and pay market level fees for appraisal services.
This creates a divide in both the cost and quality of appraisals. Many appraisals through large lending institutions (Citibank, Chase, Wells Fargo, Bank of America, etc.) are offered at low rates thus drawing less experienced appraisers who often are located far away from the location of the subject property. These appraisers don’t understand local market dynamics and have a harder time identifying appropriate comparable properties, resulting in lower property valuations.
This can leave property buyers holding the short end of the stick. Since the valuation may come in lower than prevailing market values, there may be a delta between the loan amount needed to complete the transaction and the amount of money that the lending institution will offer based on a valuation made by an inexperienced appraiser.
Finding A Solution
The solution to this problem, whenever possible, is to work with local lenders. These smaller institutions know the local markets, pay market rates for appraisals, and attract the most experienced licensed appraisers. These appraisers are more responsive and more accurate, giving buyers a greater chance of meeting lender requirements in a highly competitive market.
In some cases, smaller mortgage banks may not be able to offer the same interest rates as larger banks. It’s understandable that home buyers would want to get the best rate available, particularly on a 30 year loan where a small change in the interest rate can amount to thousands of dollars in savings over the lifetime of the loan. That said, buyers should beware. A great interest rate doesn’t count for a lot if you can’t complete a transaction because your appraisal doesn’t come in on time and at value.
Rely On Your Agent
As you evaluate a purchase and a lender, reach out to me for recommendations on mortgage brokers or other lenders that have a reliable stable of local appraisers and also offer competitive rates. I do dozens of transactions each year and have strong relationships with vendors who can help you achieve your goals.
Remember, don’t just default to your existing bank for convenience or because they tease a fast close or a great rate. Dig deep and ask detailed questions on the home appraisal process, how long to realistically expect the appraisal to take, if they use local appraisers, how many appraisals they typically require, and any other details you should understand before making a decision on working with a particular lender.
By trusting your agent and doing the legwork upfront, you will be better positioned to prevail when it comes to offer day as well as the weeks that follow during the escrow process.appraisal gap, home appraisal, local lender, mortgage lender