There are two ways to make the home loan market much more efficient by empowering borrowers. The first is to authorize borrowers to order their own appraisals. The second (considered next week) is to eliminate misleading features of the Annual Percentage Rate (APR).
Appraisals in the Current System
The appraised value of the home that a consumer offers as the collateral for a loan is a critically important piece of information. It tells lenders how large a loan they can safely make, and it tells home purchasers how much cash they need for a down payment.
Under existing arrangements, the lender orders an appraisal of a property after the borrower has applied for a loan on the property. In most cases, the order goes to an appraisal management company (AMC) which selects the individual appraiser who does the work and delivers the appraisal report to the AMC, who delivers it to the lender, who delivers it to the applicant.
It does not have to be done that way; an alternative is a system in which borrowers order their own appraisals from AMCs. This article considers the costs of the current system relative to the alternative.
Borrowers Now Pay For Appraisals But Lenders Own Them
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. While nothing prevents borrowers from purchasing appraisals on their own, lenders will not accept them, which means that they will have to pay for a second appraisal when they apply. And if by chance they decide that a lender other than the one they selected initially is the one they want, they will pay for (and wait for) still another appraisal.
In the alternative system where borrowers order appraisals, one appraisal could be used with any number of lenders within the 120 day validity period specified by current regulation.
Excessive Costs of Aborted Applications
In the existing system, consumers are denied the opportunity to see the appraisal when it will do them the most good - which is before they apply for a mortgage. In many cases, having the appraisal early on would save the consumer from a bad decision - the decision to apply for a loan for which they either cannot qualify, or which is too costly to pursue, because the property value is insufficient. This is not a rare occurrence, and when it happens it wastes the lender's time as well as that of the applicant.
In the alternative system, borrowers order appraisals before applying for a loan, which avoids the costs incurred when a low appraised value aborts a transaction.
Because appraisals are not ordered until the borrower has selected the lender, the loan process is extended by the time required for the appraisal. The average is about 2 weeks. To avoid lock expiration, borrowers need to extend the lock period, which can cost as much as ¼ of a point - or $500 on a $200,000 loan. This cost of appraisal-induced delays, which is like a tax imposed on every borrower, would be eliminated by the alternative system.
Lender-specific appraisals dampen the ability or willingness of mortgage borrowers to shop, which is hard enough without it. The disclosures that government requires lenders to provide applicants are supposed to protect borrowers by making it easier for them to shop. However, borrowers don't receive the disclosures 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 is difficult under any circumstances. The certain knowledge that doing so will require another appraisal fee makes it doubly so.
With an appraisal issued in the name of the mortgage shopper, the shopper could invite multiple lenders to make a firm offer at a specified date and time. The offer would specify the interest rate, loan fees, and lock fee, on the mortgage for which the shopper had applied. The borrower would accept one of the offers that day-- offers will lapse at the close of business -- and pay the lock fee of the selected lender. A lock fee will be necessary to discourage shoppers from walking away from deals when interest rates decline, and starting the process again with another group of lenders. But lock fees would be subject to the same competitive pressures as the other components of the mortgage price.
Making appraisals portable is one of the simplest and most effective ways to empower consumers, but it has no political constituency. To my knowledge, none of the consumer groups have touched it. I just checked the web sites of the Center For Responsible Lending and the National Consumer Law Center - not a word. I have a theory about the reasons for this which I may write about in a future article.
For more information on mortgages, or to compare loan offerings from multiple lenders in an unbaised environment, visit my website The Mortgage Professor