Home appraisers hold a lot of power in their hands — and in their calculators. They can single-handedly determine the current market value of a home.
During a real estate transaction, problems arise when the appraisal comes in below the purchase price. This forces the buyer and seller to make some tough decisions regarding the sale of the home. And, as Reuters reported earlier today, it continues to be a problem in the current housing market.
What is a Home Appraisal?
An appraisal is simply a measurement of value. In a housing context, it’s when a licensed home appraiser determines the value of a property. They are usually performed in conjunction with the sale or refinance of a home.
Mortgage lenders hire appraisers to measure property values before they’ll lend money to borrowers. After all, the lender typically has more at stake than the borrower. So they want to ensure the home is worth the amount the buyer has agreed to pay.
When It Falls Below the Purchase Price
If the appraiser determines that the home is worth at least as much as the purchase price, there’s no problem. The deal will likely go through, barring any other snags. But when the appraisal comes in below the purchase price, the buyer and seller are pushed into a corner. They must decide how they want to handle it. In most cases, it comes down to one of two outcomes:
- The seller reduces the asking price to reflect the appraisal, or…
- The seller refuses to lower the price, and the buyer walks away.
The mortgage lender will not make a loan for more than the appraised value of the home. It just doesn’t happen in the current market. So both the buyer and seller have some tough choices to make. They can accept the appraised value and work within those parameters. Or they can let the deal fall through.
Deals Falling Through
Lately, many real estate deals have fallen through because the appraisal was below the purchase price. In some cases, the sellers have an overinflated sense of their own property values. They are simply in denial about the current state of the housing market (and the value they’ve lost since the market crashed in 2008). So they price their homes too high. In other cases, the appraisals can be skewed by poorly chosen data.
“It’s hard to talk about any recovery of the housing market … until the appraisal issue is squared away, and that is a broad issue,” said Guy Cecala, publisher of Inside Mortgage Finance.
The “issue” at hand is low property appraisals. When the last housing bubble was growing, home appraisers would often inflate the value of homes beyond their true worth. This was one of the reasons we had a bubble in the first place.
The property-appraisal system was overhauled in the wake of the housing crash. New rules were put in place to curb the inflated estimates given out by appraisers. But now, many in the industry complain that the pendulum has swung too far in the opposite direction (a similar complaint to what we’ve seen with lending requirements).
Appraisals and lending standards have “gotten as outrageously conservative now as they were outrageously aggressive a few years ago,” said Rick Sharga, senior vice president of RealtyTrac.
The National Association Realtors recently surveyed its members regarding contract cancellations. Real estate professionals are reporting a rise in cancellations (year over year), and much of the blame is being placed on low appraisals.
When appraisers are more conservative in their estimates, we will have more situations where the appraisal comes in below the purchase price. It also puts downward pressure on home prices across the board. And we certainly don’t need anymore downward pressure right now. Foreclosures and unemployment are doing plenty in that department.
The New Rules for Home Appraisers
There was plenty of blame to go around after the housing market crashed. Much of it landed on home appraisers. The industry was accused of overstating property values to win favor with real estate and mortgage professionals (their bread and butter). Many in the industry have admitted to contributing to the bubble and bust.
But the rules have changed since then. Today, real estate agents and mortgage brokers are prohibited from choosing appraisers. This rule is enforced by Freddie Mac, Fannie Mae, and the Federal Housing Administration (FHA). These three organizations purchase or insure the vast majority of mortgage loans being made today. Thus, they are the rule makers.
Following all of these changes, a new “player” has emerged. Appraisal management companies, or AMCs, now act as a sort of middleman between mortgage lenders and property appraisers. Most home appraisals that take place today are performed by appraisers who have been hired by the AMCs.
Many real estate and mortgage professionals argue that the AMCs are to blame for unreasonably low property appraisals. In some cases, the AMC-hired appraiser will travel from a different part of the state, using comparable sales from a totally different real estate market. This often results in a situation where the appraisal comes in below the purchase price.
Mortgage lenders are “instructing appraisers to be a little conservative,” said Columbia Business School economist Chris Mayer. He added that this trend is “exacerbating the housing problem.”