Watch out for bloat
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 homes 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
Homeowners may at first delight in a high appraisal, especially
when theyre 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 its 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 dont 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 cant, 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 nations 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 cant sell or refinance. Communities deteriorate when the
frauds collapse, leaving abandoned homes and depressed property
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.