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Housing appraisals
Watch out for bloat

Prospective homeowners contemplating whether to purchase a house.
An inflated valuation can lead homeowners to borrow too much.

Kevin Marois, a real-estate agent in Forest Lake, Minn., had to break the news to a client that his lakefront home, which he was planning to sell, was worth about $550,000--not $639,000, an amount based on an appraisal performed a couple of years earlier during a refinancing. An out-of-town appraiser hired by a California bank had estimated the home’s value using values in a pricier community 60 miles away. Eventually, the house sold for $555,000. “If I had priced it at $639,000, it never would have sold,” Marois says.

Homeowners may at first delight in a high appraisal, especially when they’re seeking a cash-out mortgage refinancing or a home-equity loan. After all, the bigger the number, the more they can get. But an overvaluation can lead them to overborrow, and later, when they resell, they could learn that the till they thought was full of money contains much less, or nothing at all.

pressure to pump

There are no data to say how serious or widespread appraisal inflation might be, but it’s definitely going around, says Don Kelly, vice president of public affairs for the Appraisal Institute, which represents 18,000 appraisers. In a 2004 survey by the Appraisal Foundation, a nonprofit standard-setting organization, 62 percent of the 6,500 appraiser respondents said they had lost work for failing to meet a prescribed value. If house prices drop, says Kelly, the overappraisal problem could be “a ticking time bomb.”

One of the more insidious factors pumping up appraisals is the pressure coming from mortgage brokers and bank loan officers. Their commissions are based on the size of the loan, which is pegged to the value of the house used as collateral, and they don’t receive payment until the closing. So they have a direct interest in seeing properties receive the highest possible valuation. If an appraiser brings in a lower value than the agreed-upon sales price, lenders may refuse to provide a mortgage big enough. The buyer then has to come up with more cash or renegotiate. If he can’t, the deal falls apart.

So common has the complaint of pressure become that in May bank regulators--including the Federal Reserve Bank, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency--warned the nation’s lenders against interfering in the independence of the appraisal process.

Errors and fraud

Computerized mortgage underwriting programs and drive-by appraisals, which lenders increasingly use in the mortgage process, may provide additional opportunities for error, manipulation, and fraud. Many rely on publicly recorded data and can help prevent discrimination. But, says Frank Gregoire, vice chairman of the Florida Real Estate Appraisal Board, “they are not capable of doing what I can: call up a listing agent and ask why did this house sell for 5 percent more or 5 percent less than anything else in the neighborhood?”

Inflated appraisals are frequently part of criminal mortgage fraud and “flipping” schemes, which aim at ripping off financial institutions. In such cases, appraisers conspire with other parties, often mortgage brokers and developers, to pump up values on houses that are then bought and resold several times by the insiders and dumped on unsuspecting buyers. The houses often end up in foreclosure. Banks lose money, and legitimate buyers suffer because they overpay and can’t sell or refinance. Communities deteriorate when the frauds collapse, leaving abandoned homes and depressed property values.

The Federal Bureau of Investigation, in its May 2005 financial crimes report, said mortgage fraud cases had risen fourfold from 2001 to 2004, with more than 17,000 incidents of suspicious activity in 2004. In the second quarter of 2005, the FBI had 642 cases pending--more than five times as many as in 2001.

What you can do

Before buying, selling, or refinancing, research prevailing property values by reviewing recent sales and/or assessment records, available from your real-estate agent or your local government.

Ask your lender for its appraisal. If you have doubts about its accuracy--say, the comparables were from another school district--you can hire your own appraiser, though your lender may not accept his valuation. To find one who is accredited and licensed, try the Appraisal Institute at www.appraisalinstitute.org or the National Association of Independent Fee Appraisers at www.naifa.com. Generally, the fee ranges from $350 to $600.

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