A Risk Too High?

A proposed rule issued last month by the nation's six federal financial regulatory agencies seeks to establish new appraisal requirements for ‘higher risk’ mortgage loans. However, there is concern that this could discourage lenders from making such loans in the future.

The proposed rule would implement amendments to the Truth in Lending Act included in the Dodd-Frank Act by requiring lenders that make higher-risk purchase mortgages to use a licensed or certified appraiser who must perform a physical inspection of the interior of the property. Lenders would be required to provide borrowers with a free copy of the appraisal report three days before the closing.

In addition, lenders would be required to get a second appraisal – at no cost to the borrower – if the seller of the property acquired the house at a lower price during the previous six months. The aim of this provision is to weed out fraudulent property flipping by ensuring that the value of the property legitimately increased, such as through improvements.

Under the Dodd-Frank Act, mortgage loans are considered to be higher risk if they have interest rates above a certain threshold – currently, 1.9 percentage points above the average prime offer rate.
The public has until Oct. 15 to review and comment on the proposal, which some industry leaders believe is good news for consumers who fit the description of ‘higher risk.’

‘This helps to protect consumers from paying too much for a home,’ says Jacqueline Doty, vice president of collateral strategy at Santa Ana, Calif.-based CoreLogic. ‘It's well intended.’

‘Homeowners should be more comfortable than ever that their house is worth what they're paying for it,’ agrees Jennifer Creech, president and CEO of InHouse Inc. in Ponte Vedra Beach, Fla.

It also appears to be a boon for the appraisal industry, because it mandates a full-blown interior inspection of the property, which costs more than a simple drive-by or exterior-only appraisal or an automated property valuation (AVM), plus a second appraisal if the seller bought the house at a lower price in the past six months. However, the number of transactions that would be affected by the proposal is very small.
‘Some appraisers think this is good news, as two appraisals will now be required for certain high-risk loans and the appraisals must have interior inspections, which carry the highest price point,’ says Doty. ‘However, the number of lenders making higher-risk mortgages is relatively low, and the volume is also low – so it's not going to be a huge windfall for the appraisal industry.’

Indeed, the proposal excludes qualified mortgages, which currently comprise about 95% of the market. That leaves only loans that exceed the interest rate threshold, and not many lenders are currently making a lot of those loans.

‘I don't see it as having a big impact on the market right now,’ says Creech. ‘Lenders are just not comfortable taking a chance. There is not a large demand for this.’

‘Not many lenders are doing high-risk lending right now, so it may have only a limited effect,’ says Frank O'Neill, chief appraiser at San Diego-based DataQuick. However, he adds, it could be more of an issue going forward as the housing market improves, the mortgage market loosens up and lenders are willing to make loans other than plain-vanilla loans.

It may also discourage lenders from making higher-risk loans in the future, appraisers say. The added cost of a second appraisal, if required, which lenders would not be allowed to pass along to the consumer, is only one of the reasons. It also could cause operational problems. Scheduling an interior inspection from one appraiser can be problematic, but two may be more difficult.
‘It will slow down the process,’ Doty contends. ‘A lender could order both appraisals at the same time, but each appraiser must schedule an appointment to obtain access to the property in order to complete the assignment. This will extend the mortgage processing timeline.’

This could be a particular problem in rural areas, where appraisers are few and far between, says Jeryl Graham, executive vice president of valuations at Maitland, Fla.-based ISGN. Graham notes that, for example, appraisers in North Dakota are currently stretched to the limit by a housing boom driven by the oil pipeline. That has raised the price of an appraisal in North Dakota to $1,500 for some properties, which is about five times the cost of a typical appraisal in states like Florida and California.

But scheduling appraiser visits may be an easier problem to solve than reconciling two conflicting appraisals.

‘Two appraisers never view a property the same way,’ says Creech. ‘It is subjective, and there are differences in valuations. That will mean the lender and the underwriter will have to come up with a way to reconcile the two appraisals.’

Creech adds that lenders will need to have a greater level of sophistication to resolve any differences between the reports.

The proposed regulation would also mandate that lenders get the appraisal report to borrowers three days before the closing.

‘That's really going to be onerous to a consumer who wants to close on time,’ says Graham. ‘Most closing packages go right up to the wire. It will be difficult to get the report there three days before.’

Delaying the closing could affect interest rate locks on mortgage loans, Graham notes, which could be costly to the borrower. As a result, lenders and appraisers will have to look at different ways to speed up delivery of appraisal reports, such as sending them via electronic mail rather than regular mail.

George Yacik is a Stratford, Conn.-based financial writer. He can be reached at gyacik@yahoo.com.


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