New rules have been adopted governing residential mortgage loan appraisals. These rules are intended to assure the independence of appraisers from the lending institution by requiring appraisers to be selected by an independent appraisal management entity.
The problem that this is designed to solve is lender pressure on appraisers to reach a desired number. This type of requirement was caused by the perception that appraisals were somehow responsible for the excesses of the sub-prime loans that brought about the collapse of the residential mortage market. Undoubtedly, there were some incompetent or dishonest appraisals. However, these appraisals most probably did not occur in a significant percentage of the appraisals involved in failed mortgages. There were many other problems that most probably had a far greater impact.
There are many complaints that these new rules just increase the cost of the trnsaction and negatively impact the borrower. The complaints seem to have merit.
Legislators and regulators must be mindful of the fact that lax underwriting standards, low down payments, low interest rate adjustable mortgages, excess speculation and the fact that the originator (lending institution) did not plan to hold the loan for its investment. Rather, the loans were to be packaged and sold off in mortgage based securities so that 100% of the risk in the loan was transferred to the buyer of those secirities. If underwriters had been diligent in qualifying borrowers to make sure that the borrower could service the debt and retained the risk if they couldn’t, then much of the pain in the mortgage market might have been avoided.
What lenders and regulators must remember is that there has never been any assurance that a given property will hold its value or increase in value over time. Usually, due to the passage of time, values may change either upward or downward and it is the downward shift that causes the problem. Unfortunately everyone believed that real estate values could only go up and thus weren’t too concerned about value related defaults. But, the fact is that when values decline, for whatever reason, there is a very hig risk of defaults particularly impacting the most recent buyers who acquired at a market top. When a default occurs it really doesn’t matter whther the property was valued at the price paid on acquisition. So, the origination appraisal really does not provide much safety for the lender in a default situation.
The less equity that a person has in the property, the greater the default risk in a down market. Where downpayment requirements are 10% or less it really doesn’t take a major downturn to put debtors under water. The real support for a mortgage loan should be the amount of equity held by the borrower and the borrowers proven ability to repay. If lenders were making loans for their own investment portfolio, the degree of underwriting due diligence would most probably be greatly enhanced but when the created loans can be packaged and sold off as mortgage backed securities, no one in the process bears any of the liability. The liability is transferred to the purchased of the securities.
The regulators and lawmakers should focus on the entire process and not just on the appraisal portion of underwriting. But, knee jerk reactions and laws seem to be the order of the day.
