Understanding A Mortgage Appraisal

Account Closed · 2020-04-05T13:31:19-07:00

Understanding a Mortgage Appraisal - Part 1 The first thing to understand is appraisals are not all the same or equal. In fact, each appraisal is unique to the needs of the specific client. Mortgage Appraisals are the most common type of appraisals completed. They are also specific to the needs of the client. The client is the bank, not the borrower, never the borrower. An appraiser must first communicate with the client in all cases before completing an appraisal for hire. Certain questions must be answered, most significantly the need for the appraisal, what it will be used for, and what the expectation of the client is. The answers to these questions are necessary allow the professional appraiser to develop an appropriate scope of work to satisfy the needs and expectations of the client otherwise, it will allow an appraiser to let the client know up-front they are not able to solve the clients appraisal problem. In this way, the client can hire the appraiser and expect to receive what they are paying for. USPAP requires this in all assignments. USPAP is an acronym for the Uniform Standards of the Professional Appraisal Practice. USPAP itself is not the law however, many government and other agencies have adopted it and so in some cases it is the law to follow it, this happens most often at the state level. Mortgage appraisals are specifically designed to serve the finance industry - the lender. With rare exception, all mortgage appraisals are developed and reported according to the lender on a uniform form. These forms were designed and created by Fannie Mae and Freddie Mac. The single-family interior-inspection form, the most common, is called the Uniform Residential Appraisal Report or URAR, form 1004 and form 70 for Fannie and Freddie respectively. There are also forms for multi-family, condos, mobile homes and numerous other types of properties and assignments. It is critical to understand these forms were designed and written by the client, not the appraiser, and by doing so, certain aspects of the appraisal are not appraiser-friendly. What I really mean are parts of the form are not possible to complete in a credible manner. You might think somebody might change things to make sure the most relied upon form in the entire industry aligned with all parties, but that is not the case and a bit of a mystery as to why. This is why when borrowers, and even loan brokers sometimes, read a mortgage appraisal and think that it doesn't make a lick of sense, they're right, it doesn't. At least not to them. Fannie Mae and Freddie Mac are fully aware of the form flaws. It is not easy for them to simply roll out new forms. This has been done numerous times and each time it happens, it disrupts the workflow of the industry in a significant way. If I said one thing about the way forms have been designed, it's to accomplish a task in the simplest and cheapest way possible. A person might wonder why cost is relevant to the quality of an appraisal report. They might argue that cost ought never be a consideration when it comes to credible results. Often, it's appraisers who make that argument, and in a way they're not wrong. However, the business of lending is a business, and to have a business you must have customers and you must make a profit. The cost of the appraisal in the current lender business model is passed on to the person applying for a loan. This is a strange arrangement, considering the applicant is in fact purchasing something for the bank and not for themselves. However, when people want something enough they will pay for it, and that's market economics 101. Therefore, the cost of the appraisal in the current model is actually determined by the consumers willingness to pay, and we get what we pay for. Consumers are currently willing to pay about $300-$500 on average for an appraisal that might not get them anywhere. Subsequently, the forms have been designed with that fee amount to be paid to the appraiser in mind. Again, this is market economics and how to run a business within the living economy. To summarize the main points so far, all appraisals are unique to the needs of the client. The needs and expectations of the client must be established up-front before an appraiser can proceed with any appraisal assignment. Mortgage appraisals were designed by and for lenders, lending and the business of lending. Lending forms do not always align with what is actually possible. Borrowers typically pay for the appraisal, but it is not their appraisal. Persons unaware of these things who might read a mortgage appraisal might not understand it and, I will add here, could be subsequently misled. Misleading information can be dangerous.

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Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

6y

Understanding A Mortgage Appraisal - Part 2

Mortgage appraisals require the appraiser to adhere to the USPAP when being completed. Written appraisals reports and verbal appraisal reports have different requirement standards to follow under the USPAP. Mortgage appraisals are written appraisal reports as defined in the USPAP. All written reports must provide factual market evidence to support the appraisers conclusions according to the USPAP. This is why each mortgage appraisal has three comparable sales presented. USPAP does not require an appraiser to provide conclusive or comprehensive proof, only factual market data to support the opinion. This is why three comparable sales are considered acceptable and not more. Again, there is a function of cost to keep in mind here - few people are willing to pay more than a few hundred dollars for an appraisal and presenting comparable sales is one of the most time consuming parts of completing an appraisal.

What is a fact and what is an opinion? Very little of what ends up in an appraisal is a fact. Much is assumed as fact. For the most part, only the property address, date of sale and price of a comparable sale is fact. And even then, those facts can be wrong. That is why I did not include the size of the land, the size of the house, the age of the house, and so on, because all of those things are subject to error. An appraiser is required to verify each sale used in an appraisal for support of the opinion however, verification can be in error too (it is also time consuming and/or impossible). In consideration of providing factual market evidence in support of the opinion, the actual sale price of a comparable property is the only true market evidence relevant to the requirement. All other information provided supports that fact. And to really give your brain a headache, consider for a moment that each sale is actually an opinion between a single buyer and a single seller, who have come to a single agreement, when the next buyer and seller may have come to an entirely different conclusion with respect to the sale price of the property! LOL - They call that an opinion my friends - LOL.

This brings us to market data and how it relates to an appraisal, which I will cover in Part 3.

To summarize this segment, mortgage appraisals are in writing and USPAP requires factual market evidence to be included within a written report to support the opinion of the appraiser. This factual information is not required to be proof, and does not need to be comprehensive. The matter of fact vs opinion is a matter of definition and application, which is not always black and white. Appraisers must do their best to verify all information in an appraisal report, but perfection is impossible to attain and therefore not required.

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Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

6y

Understanding A Mortgage Appraisal - Part 3

A professional appraiser may not simply form an opinion of property value and charge money for that. An appraiser must form an opinion of property value according to the opinions of others. The opinions of others are called market data. For the purposes of an appraisal, these opinions are accepted as facts, known as factual market evidence.

Mortgage appraisals, as well as most real property property appraisals completed, present individual sales as market evidence, also known as comparable sales. It is not required under the USPAP to employ this type of evidence. It is up to the appraiser and client to decide what evidence is acceptable. It would also be perfectly acceptable to simply provide a general list of sales data if the client agreed it would satisfy their expectation and the appraiser agreed it was an acceptable scope of work for the type of assignment. In my opinion, providing a general list of sales would be a better method for mortgage appraisals than providing only three sales intimately. It would certainly be cheaper, and would better reflect the true nature of the appraisal and what it means to all parties. In other words, it is my opinion that the current method of three comparable sales can be misleading, and one of the other things the USPAP requires of appraisers is they never present an appraisal report in a manner that is misleading.

The three comparable sales presented in a mortgage appraisal are reported on a sales grid. On the sales grid, each sale is reported specifically and in great detail. The details include numerous aspects of the property, each are either designed to report a lender requirement or element of value to be considered. For instance, reporting if a sale was arms-length or what type of financing was used is not an element of property value, though it could have had an impact on the price at the time of sale (meaning it was a circumstantial factor). The size and quality of the house would be an example of tangible property elements of value. It is critical to understand these differences as an appraiser, as the same data can be used in multiple ways for multiple uses.

Once the subject property and comparable sales have been presented in the sales grid, the appraiser can then analyze each sale for similarities and differences as compared to the subject property - hence the term comparable sales. The problem here is, zero properties are identical. This forces the appraiser to consider if these differences are significant and then if they are relevant to the the price of the comparable sale.

For instance, if the subject property had 2000 square feet of living area and a comparable sale had 3000 square feet of living area, the appraiser must figure out if the difference is significant and if so, if it's relevant. In this example and in most cases (not all), a difference of 1000 square feet of living area would be considered significant. The next consideration would be if it's relevant to prices paid in the market.

Not all significant differences are relevant. For instance, another example would be a lake property. Maybe the subject property has 50 feet of lake front and the comparable property has 75 feet of lake front. The difference might appear significant on paper (50% more), but it might turn out a 50 foot lakefront property and 75 foot lakefront property sell for the same price in the market.

Going back to the first example, it might turn out that a difference of 1000 square feet was not relevant in homes that are 5000 square feet or more, but very relevant to homes that are between 1000 square feet and 2000 square feet.

What I have illustrated here is how an appraiser must go about analyzing and adjusting the subject and comparable sales for differences between existing housing stock where none is identical in a mortgage appraisal. The next obvious question is how do appraisers do that???

To summarize this segment, an appraiser must form an opinion of the opinions of others. They do this employing market data. All written reports require examples of this market data, known as factual market evidence, according to the USPAP, when verbal reports do not. The selection of market evidence is a decision made between the appraiser and the client, and the USPAP does not specify any specific type or quantity, only that it is acceptable to all parties. It is this writers opinion that the current method of providing three comparable sales intimately is inferior to employing a general list of many comparable sales as the use of only three sales in an intimate manner can be misleading to the reader, and the USPAP requires an appraiser never mislead the reader. Once these three comparable sales are presented on the grid, the appraiser must reconcile all differences between the subject property and comparable sales in terms of significance and relevance, and no two properties are ever identical.

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Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

6y

Understanding A Mortgage Appraisal - Part 4

As stated in earlier segments, the USPAP does not dictate what type and quantity of market evidence is provided along with a written appraisal report. Mortgage appraisals, designed and written by the client, not the appraiser, require the use of at least three comparable sales to be presented as evidence. In addition to serving as evidence, the report format calls for the appraiser to reconcile the differences between the subject property and comparable sales in terms of prices paid. The result of this reconciliation is the Adjusted Sales Price of the comparable sale.

Each comparable sale on the sales grid will have the Actual Sales Price at the top of each property and the Adjusted Sales Price at the bottom. The Actual Sales Price is fact and the Adjusted Sales Price is an opinion.

To arrive at the Adjusted Sales Price, the appraiser divides the subject and comparable sales into various elements of value; size, location, amenities, view, terms of sale, etc. I haven't counted in a while, but last time I did I think I counted 32 pre-printed elements of value to adjust for on the sales grid on the 1004 form, with 4 or 5 blank spaces at the bottom for write-ins. By virtue of the form format, the appraiser must consider each and every one of these elements and is responsible to include in addition any relevant elements not pre-printed.

But how does an appraiser determine the value of each element??? How do they indeed. The Fannie Mae Selling Guide, the contractual agreement between originating lenders and Fannie Mae, requires the underwriter verify that all adjustments to the comparable sales have been supported in the appraisal and have been made when necessary. If you wonder how an appraiser does it, then wonder how an underwriter that is not an appraiser verifies it has been done!!! If an underwriter can not verify the adjustments are supported and made, the appraisal does not satisfy the requirements set forth in the Selling Guide and the loan is not deliverable to Fannie Mae. When originating lenders deliver loans for purchase to Fannie Mae that do not meet all the requirements of the Selling Guide, Fannie Mae requires the originating lender buy the loan back. You see, FNMA pretty much buys loans sight unseen with an agreement that all loans delivered in fact meet all guidelines. I'm getting off the point here, but it's important to the story of mortgage appraisals and lending that is coming up later.

The most trusted and reliable method of extracting market values for elements of property value is the Matched Pairs Analysis. It is not perfect, but it is the best available. There are other methods I will not explain in detail, but suffice it to say all others are inferior in terms of credibility. Matched Pairs Analysis is considered a sound method when developed, the problem is it can rarely be developed. I'll explain how it works and you will be able to see how it is rarely possible to do it. Keep in mind Matched Pairs is as good as it gets by a long-shot in terms of a credible method to determine the market value of adjustments, and market value they must be, or the appraisal is no longer defined in terms of market value.

Matched Pairs works by finding two properties comparable to the subject. These two properties must first be generally comparable to the subject, where the test of comparability there is if a buyer could not purchase the first property, they could purchase the second property and believe it was an equal substitute to the first. Second, these two properties must be identical to each other in all ways with exception to one thing. For instance, all elements were equal except the first property has one bathroom and the second property has two bathrooms. This is called isolative data (well, I call it that anyways). Using that example, the difference in price between the first property and the second property can be concluded to be the market value of the additional bathroom. Pretty simple, pretty sound, sort of.

But there are some problems here. For starters, properties are rarely only different from one another by a degree of one. Further, in order to complete the entire appraisal, where there are numerous elements of value that must be isolated and market values extracted, the appraiser would have to find pairs of comparable properties that exhibited each of the various property elements. Considering 32 pre-printed elements of value to reconcile on the 1004 form, that means 64 comparable properties, placed into 32 pairs, all representative of the individual elements of value respectively. Anyone ever do a comp search? To say that's a tall order is an understatement. I might play the lottery and expect better odds.

The other problem to consider here is even if matching a pair is possible, how can an appraiser be certain the value indicated is accurate? It would be silly think a single comparable property might be enough market evidence to support an appraisal of property, so would not the same be true of an adjustment? Would not the appraiser want to test the value indicated by running more matched pairs? Of course they would. Now how many comparable properties are needed?

Another problem is how does the appraiser know the difference in price between matched pairs is coming from the difference in elements? Is it not true that people pay different amounts for the same property? Is it not true that different sellers employ different selling strategies? How about different realtors? Indeed, one can not say for sure if the difference in price between matched pairs is truly attributed to the difference in property.

What does this all mean? What do appraisers actually do to solve this problem?

Well, it means what it sounds like, the adjustments are not supported, because the appraiser can not complete the method in most all cases. Appraisers must punt (using a football term). They must either employ an alternative method which I said before is not as reliable by a long-shot or, they use their own judgement. Both of these are poor choices and do not stand up to the requirements of the USPAP or the expectation of the client. Yet, millions of mortgage appraisals are done every year in exactly this way.

This is why I started this segment explaining the difference between the Actual Sale Price and the Adjusted Sales Price. At the end of the day, it is the Actual Sales Price that can be relied upon only. A smart appraiser will recognize this, and so does the client (the bank). This is why the final opinion of value in the appraisal report will (almost) always fall between the lowest and highest Actual Sale Price. It's a judgement call, just like almost everything in the appraisal. What is misleading to a reader who does not understand this, is they unwittingly believe the sales grid and adjustments have merit when they do not - these are employed methods that at the end of the day have been dismissed after development as meaningless and therefore irrelevant.

All appraisals employ numerous methods and all appraisers must reconcile those methods at the end of the appraisal. This is called the final reconciliation. There are numerous reconciliations that take place during an appraisal, but this one takes a look at each method employed and makes a judgement to whether or not the method can be relied upon or not. The thing to remember is the developed methods will be reported in the appraisal whether they were granted any weight in the final reconciliation or not. The greatest example of this is between the Three Approaches to Value required in all appraisals according to the USPAP - The Sales Comparison Approach, The Cost Approach and the Income Approach. Mortgage appraisals in most all cases do not even bother to develop the Cost and Income Approaches at the start as they are dismissed as unnecessary and usually meaningless by most all appraisers and appraisal clients when market value of a single family residence is the subject property.

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Investor · Milwaukee, WI · Member since 2013 · 1k+ posts · 1k+ votes

6y

Understanding A Mortgage Appraisal - Part 5

Now that I have covered the basic nuts and bolts of how a mortgage appraisal works, I want to touch on one last subject - rights of use. I also want to wrap up a few interesting tid-bits I sort of glossed over during the previous segments, like how an underwriter can review an appraisal and if not, what that is supposed to mean.

Only the client, the originating lender, is named as the intended user of the appraisal. There are other parties that are named as additional users of the appraisal, but the difference is that the appraisal was written and developed specifically for the intended user, not the additional users. This means when additional users go ahead and read the appraisal or rely on the results, they may not understand what they are reading and the appraisal may not serve the purpose they are using it for. That's dangerous.

The most common and dangerous misuse of an appraisal is by the borrower for the purposes of satisfying an appraisal contingency in a purchase agreement. For starters, the borrower has zero permission to do this. The only permission granted by the appraiser to the borrower is to rely on the appraisal for the purpose of obtaining a mortgage loan. The thing to keep in mind here again is context of use. A mortgage loan is typically only 80% of the property value. That means the appraisal is there to serve and protect 80% of the value, not 100%. When borrowers want to borrow more than 80%, the bank realizes the risk involved when relying on an appraised value and so requires an insurance policy be purchased to cover that risk. This is what mortgage insurance is (PMI), an insurance policy purchased by the borrower, with the bank named as the beneficiary, that will cover the loss of the top 20% in the event of default. This covers the bank, not the borrower mind you (could be a new product for mortgage insurance companies to insure borrowers). When a borrower uses a mortgage appraisal to satisfy an appraisal contingency, not only are they already off by 20%, but the expectation of the seller and buyer in a purchase is to use the appraisal contingency to negotiate amounts usually much less, maybe a couple thousand dollars. The moral here is that again, each appraisal is unique to the assignment and using an appraisal not designed for a second purpose can be very dangerous.

The other part of the story that never gets told when using a mortgage appraisal for an appraisal contingency is that the USPAP requires appraisers analyze all current agreements of sale if available. While I do not agree with this requirement, it is in there and it is followed in all cases. That means the appraiser knows what the purchase price is and because they are doing the appraisal for a mortgage (80%) for the bank and not a purchase (100%) for the buyer (notice I did not say borrower), the relevance of knowing what the purchase price is in terms of performing an unbiased appraisal is not significant to the client or the assignment. Again, this comes down to ignorance and expectation. Most often, borrowers who are also buyers do not know any of this stuff and unwittingly use the appraisal to save money and time, when all they are buying themselves is a bad information. Realtors might be keen to this, but they aint saying are they? Loan officer don't care either.

Finally I'll discuss the underwriter and their inability to verify appraisals. The FNMA Selling Guide states all adjustments must be supported and made when necessary. Clearly an appraiser can not do that, so how would an underwriter verify it? They can't. So technically, any appraisal that can not stand up to the written requirements can not be used as an acceptable valuation of the collateral asset. That's a fancy way of saying the loan is not deliverable to Fannie Mae. I know they know this, and wonder why they might not makes changes. One reason they might not make changes is because if a loan defaults or not, Fannie Mae does not have to force a buy-back - it's their choice in either case. So by making the rules impossible to follow, they hold a trump card to force a buy-back on every loan in every case, default or not. LOL. How's that for leverage?

To conclude. Mortgage appraisals are for banks, not borrowers, not buyers, not sellers, not realtors. Anyone other than the bank that uses one is taking a risk. Parties other than the bank (who is intimately knowledgeable of their own appraisals) that attempt to understand a mortgage appraisal will likely not understand it. Unauthorized parties that use the appraisal for unintended purposes could suffer financial loss. Nobody in the industry that acts as a borrower/buyers "partner" is going to say anything about any of this, if they even understand it themselves, because it is not in their interest to do so.

Moral of the story??? Understand a mortgage appraisal. Best course of action concerning mortgage appraisals? Never even possess one unless you are an underwriter and are forced to decipher one. Having one in your possession will likely only poison your mind and drive you crazy.

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Understanding A Mortgage Appraisal

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