Shift Control of Appraisals to Mortgage Borrowers: Some Further Thoughts

In our current housing finance system, appraisals are issued in the name of the lender to whom a prospective borrower has applied for a loan, and it is not transferable to another lender. In last week's article, I argued that mortgage borrowers who paid for appraisals should own them, and should be able to use them with any lenders to whom they apply.

The switch to a borrower-ownership model would reduce the number of applications that are aborted when the appraised value turns out to be too small to support the transaction. It would reduce the time required to execute purchase transactions. And it would facilitate mortgage shopping by eliminating the need to pay for multiple appraisals. In addition, the price of appraisals would fall for reasons discussed below.

Shifting to a system of borrower control of appraisals does not mean that borrowers would select appraisers. That would open the door to the same abuses that arose when lenders selected appraisers. Rather, borrowers would purchase their appraisal from an appraisal management company (AMC), which would select the appraiser assigned to a property, and would be responsible for the quality of appraisals and the independence of the appraiser. AMCs would be subject to approval by the Federal agencies, which would look to AMCs rather than lenders as the principal guarantors of the integrity of appraisals.

Approved AMCs would compete for the business of potential borrowers in terms of price, which would reduce the cost of appraisals. Under existing rules, appraisals are ordered by lenders who have no incentive to negotiate lower prices. In many cases, lenders have an ownership interest in the AMC to which they send business. Such ownership interests in effect legalize referral fees. They will disappear under a system of appraisal control by borrowers.

Some readers raised questions about whether implementation of the proposed rule would be costly or disruptive, so I decided to take a quick look at that question. The first thing I looked at was the Uniform Residential Appraisal Report, which is the document that contains the appraisal, and is universally used. Implementation of the proposed rule would require that the term "lender/client", which appears in a few places on that form, be replaced with "client ". That's it.

I also looked at the Fannie Mae selling guide, which sets out the requirements for selling mortgages to that agency. Fannie's guide says that "The lender is responsible for ensuring that the subject property provides adequate collateral for the mortgage." Since it buys mortgages from lenders, it is understandable why Fannie would want to hold lenders responsible for the quality of appraisals, and for their independence from influence by interested parties. Yet the lender is not nearly as well positioned to assume those responsibilities as the AMC.

The AMC hires appraisers after examining their credentials, assigns them to appraise properties, and monitors and evaluates their work. This is the major function of an AMC, whereas for a lender it is strictly a sideline. In addition, lenders are not always or entirely disinterested in whether appraisals are high or low, since they are participants in the transaction. AMCs in contrast are disinterested - except perhaps in cases where a lender has an ownership interest in the AMC. In that case both parties may tolerate lower-quality appraisals. An important side benefit of shifting control of appraisals to borrowers is the elimination of lender ownership interests in AMCs.

In a market in which prospective borrowers own the appraisals they purchase through AMCs, and the Federal agencies certify the AMCs, lenders still have a role. The agencies will want lenders to approve appraisals, as they do now, and might specify acceptance criteria such as a maximum divergence from an automated valuation. Whatever the rules governing lender approval turn out to be, lenders should be barred from directing applicants to specific AMCs. They could offer a list of agency-certified AMCs, and that's all.

The relevant sections of Fannie's seller guide would have to be revised to incorporate the shift to borrower control of appraisals, the shift in responsibility for appraisal quality from lenders to AMCs, the formulation of requirements for approving AMCs, and the new diminished responsibilities of lenders. I don't view this as a major project, but others might disagree.

Thanks to Jack Pritchard and Tara Twomey.

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