If You Need a Mortgage to Buy a House, You Also Need an Appraisal

"I used your site to connect with one of your certified loan providers... While I provided all the documentation they asked for in a timely manner, the lender did not close within the lock period and is now asking me for $1,000 extra to cover a rate lock extension. The lender says that the holdup was due to the property appraisal not getting done on time because of a shortage of appraisers in Oregon, where I live, and that this was outside of their control...What is your advice in this situation?"

There is a shortage of appraisers in Oregon, as well as in several other states, and this is indeed outside the control of lenders. Of course, it is also outside the control of borrowers.

When a lock expires for reasons outside the control of both borrower and lender, my advice is for them to split the incremental cost down the middle. When lenders react to an appraiser shortage by refusing to lock until after an appraisal has been received, which is a logical reaction, my advice to borrowers is to make sure they can easily monitor their price day by day as the market changes. They can do that on my site as well as on others.

The big questions right now are why appraisals have become a bottleneck in some parts of the country, whether shortages could become more widespread, and what can be done about it?

Appraisers Are Underpaid

When a service is in short supply because of a shortage of service providers, the first thing to look at is how the providers are compensated. Before the financial crisis, appraisers earned about $450 per inspection. They were self-employed individuals, licensed by the state, selected by lenders and paid by borrowers. Today, lenders select appraisal management companies (AMCs) which retain appraisers, paying them about $200 an inspection, often less. Borrowers pay about the same appraisal fee as they did earlier, but now half or more of what they pay fills pockets other than the appraisers'.

The result has been a decline in the quality of appraisals, a de-professionalization of the industry, and a shortage of appraisers in some areas that could get worse. The cause is misguided regulation.

Mandating That Lenders Deal With AMCs Was Misguided

The major function of AMCs is to act as a buffer between lenders and individual appraisers. In the aftermath of the financial crisis, as part of the frenzied search for villains, the view took hold that appraisers were accomplices of lenders who retained them in making imprudent loans at inflated prices, setting the stage for a collapse in prices and a flurry of borrower defaults. Hence, the rule was adopted that lenders had to order appraisals from AMCs, which would select the appraisers.

This regulation resulted in an additional cost which had to be borne either by borrowers or appraisers. Imposing it on appraisers was the path of least resistance - there are many more borrowers than there are appraisers -- but the consequences are now being felt.

AMCs are a costly fifth wheel because there are other ways to ensure the integrity of appraisals against lender influence that do not short-change appraisers. The best approach, which has several benefits in addition to protecting the integrity of appraisals, is to authorize borrowers to order their own appraisals directly from appraisers.

Borrower-Ordered Appraisals

A system in which borrowers ordered appraisals directly from appraisers would generate a series of benefits.

Lenders Would Ensure the Integrity of Appraisals: While borrowers might seek out appraisers who would give them the appraisal they want, lenders would have the right to reject an appraisal and/or maintain lists of appraisers that do not meet their standards.

One Appraisal Can Be Used Multiple Times: Under existing arrangements, borrowers pay for the appraisal but it carries the name of the lender who ordered it. For all practical purposes, the appraisal belongs to that lender because the borrower cannot use it with another lender. If borrowers ordered appraisals, one appraisal could be used with any number of lenders within the 120 day validity period specified by current regulation.

Reduce Processing Time: In the present system, appraisals are not ordered until the borrower has selected the lender, which increases processing time by the period required to obtain the appraisal -- ordinarily about 2 weeks but longer when appraisers are in short supply. This delay increases the cost to borrowers of locking the price. If borrowers could order appraisals before applying for a loan, this cost would be eliminated.

Avoid Costs of Aborted Applications: Under existing arrangements, loan applicants are denied the opportunity to see the appraisal before they apply for a mortgage. The result is that sometimes consumers incur needless costs when the property value turns out to be insufficient. If borrowers could order appraisals before applying for a loan, they could avoid the costs incurred when a low appraised value aborts a transaction.

Increase the Effectiveness of Consumer Shopping: The disclosures that government requires lenders to provide loan applicants, designed to make it easier for them to shop, are not received until after they have applied for a loan and paid for an appraisal. For a borrower to withdraw at this point in order to begin again with another lender requires another appraisal delay and another fee. With an appraisal issued in the name of the applicant, a major shopping cost would be eliminated.

For more consumer guidance on mortgage issues or to shop for a mortgage in an unbiased environment, visit my website The Mortgage Professor.