What is appraisal fraud?
Appraisal fraud involves the falsification of an appraisal to justify a value that may not accurately represent the true market value of the property. For instance, an appraiser may fraudulently justify an inflated market value by using comps that are not really similar properties or ignoring property defects that negatively impact value. Typically this is done in response to pressure from mortgage brokers, lenders, or even real estate brokers to “meet the mark” — that is, the amount required to sustain the sales price and bring the loan to a close. Often this means that the appraised value ends up equaling the contract price.
What are the consequences of appraisal fraud?
Buyers: A recent report from the New York public policy think tank Dēmos (www.demos-usa.org) indicts appraisers for the increasingly widespread overvaluation of residential properties. “Home Insecurity: How Widespread Appraisal Fraud Puts Homeowners at Risk”
(www.demos-usa.org/pubs/home_insecurity_v3.pdf) warns of the dangers that loom for homeowners if appraisal fraud continues unchecked. When a buyer’s purchase loan exceeds the true market value of the home, there may be dire consequences if the owner is unable to later sell the property for enough money to pay off the mortgage and any other liens on the property. The scenario will be much worse if the “housing bubble” bursts and values tumble. The end of the road for many of these buyers may be foreclosure and potential bankruptcy. Putting buyers into homes and mortgages that they cannot afford is not serving the best interests of these buyers. Homeownership is not the American dream if it ends in the nightmare of foreclosure and possible bankruptcy.
Mortgage Fraud: Appraisal fraud is often a component of mortgage fraud. For example, a mortgage broker wants the parties to rewrite an accepted offer for $95,000 as an offer for $125,000 with $5,000 in credits to the buyer and a second mortgage of $25,000 which the seller is to forgive after closing. If the real estate agents and the parties comply, and the mortgage broker successfully pressures an appraiser to appraise the home for at least $125,000, the transaction closes and everyone lives happily ever after, right? The buyer gets the house he or she wanted, the seller receives the original $95,000 sales price, and the mortgage broker, the appraiser and the real estate brokers all get their fees and commissions. However, when this loan is bundled and sold on the secondary market to investors, it’s the investors who pay the price if mortgages are foreclosed and the properties are worth less than the loan amounts.
Appraisal Inflation in the Real Estate Market: The next time an appraiser uses the above hypothetical $125,000 sale as a comp when valuing a similar property, the values of other similar properties in that market area also become artificially inflated. The property values in a neighborhood or community ratchet higher and higher, pushing the envelope of real estate prices until the market can no longer sustain further price increases and the real estate price bubble bursts.
Who is to blame?
Appraisers: Many appraisers are willing to acknowledge that the blame for appraisal fraud rests with appraisers. If all appraisers were ethical and refused assignments from lenders and others who dictate appraised values, appraisal fraud would diminish. Appraisers, however, are not alone in appraisal and mortgage fraud schemes.
Pressure on Appraisers: The Dēmos report cites the intense pressure facing appraisers as part of the cause for inflated housing values. Appraisers face stiff pressure from all directions to inflate values, revise appraisals or promise to hit a predetermined value. Mortgage brokers and lenders push for appraisals reporting the desired property values, and punish those appraisers who do not accommodate them by cutting them off from future appraisal assignments, refusing to pay them, and blacklisting them throughout the lending community. Some appraisers may find that they can no longer support themselves and their families in the appraisal profession. The national appraisal survey conducted by October Research in 2003 found that over 55 percent of appraisers reported feeling pressured to overstate property values.
Mortgage Loan Process: The system enables appraisal fraud. Mortgage brokers, lenders and real estate brokers generally are paid a commission based on loan or transaction values. Homeowners who are refinancing to pay off other debt need the new loan to come in high enough to cover this debt. Those who originate loans care little if the mortgagor later defaults because the loans are sold into the secondary market. Most appraisers work primarily for lenders and mortgage brokers and lose their livelihood if their clients are not pleased.
Mortgage Brokers, Lenders and Real Estate Brokers: The mortgage brokers, lenders, real estate agents and the parties themselves are all potential accomplices to appraisal and mortgage fraud because they all have a financial stake that is dependent upon the success and the size of the transaction. Commissions, fees and proceeds are received, while the buyer is left at risk and may pay the price for the greed and unscrupulous behavior of those providers who participate in appraisal and mortgage fraud. That certainly is not to say that all appraisers, lenders, mortgage brokers and real estate agents commit fraud and engage in shady deals – most are honorable professionals who conduct themselves with the utmost integrity and honesty. It only takes a few bad actors to besmirch the reputation of a profession. Intensified sanctioning of appraisers may not be effective unless their collaborators are also held accountable.
What can be done to combat appraisal fraud?
The Dēmos briefing paper recommends that appraisals should be ordered and paid for in a manner that won’t allow mortgage brokers, lenders and real estate agents to pressure appraisers. Tough penalties for those who do attempt to exert such influence over appraisers are also recommended. Other Dēmos recommendations include a streamlined complaint process and increased enforcement capacity.
Many appraisers want appraisals to be ordered and paid for by objective parties (i.e., an intermediary organization that is not paid on a commission basis), and endorse stiff and immediate penalties for anyone who pressures appraisers to inflate appraisals. Licensing of loan officers and mortgage brokers and an independent appraiser regulatory body are also often suggested.
Lender Oversight: The lending community appears to have taken notice that the system may be starting to be a bit too liberal in the residential mortgage loan arena. On May 17, 2005, the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration issued a joint guidance to the lenders that they regulate, urging banks and credit unions to impose tighter credit risk management practices and stiffer underwriting standards. Responding to the surge in interest-only loans and adjustable rate mortgages (ARM), lenders were also warned to be cautious when dealing with mortgage brokers who are not bank employees and who are paid by commission based on the volume of loans they produce. Lenders are urged to retain oversight of all critical loan-processing activities, including verification of income and employment, and ensuring independence in the appraisal and evaluation functions.
Legislative Proposals: The Appraisal Institute has gone on record in support H.R. 1295, the Responsible Lending Act
(www.appraisalinstitute.org/govtaffairs/downloads/SubprimeBill_Draft030305.pdf), introduced in Congress on March 15, 2005. This bill proposes numerous changes that are described as intended to protect mortgage borrowers, combat predatory lending, improve industry standards and improve the appraisal process. Proponents of H.R. 1295 say that it would prohibit parties interested in a real estate transaction from improperly influencing appraisers through coercion, extortion or bribery. The bill also establishes uniform regulation of mortgage brokers that includes high standards, increased oversight and a national registry of mortgage brokers.
Opponents of H.R. 1295 agree that the issues raised by the bill are worthy of attention, but they are alarmed that uniform federal standards will weaken the existing, stronger consumer protections found in state law, and point to loopholes in the bill that undermine the stated purpose of many key provisions. One instance of this occurs with the provision prohibiting all lenders, mortgage brokers, banks, real estate brokers and all other persons from improperly influencing appraisers: there is an exception which allows these parties to ask appraisers to consider additional property information, provide further explanation for the appraiser’s conclusions, and correct errors in the appraisal. This would appear to authorize lenders to lead appraisers to the values they desire. Similarly, the provisions establishing education requirements and a national registry for mortgage brokers exempt banks, credit unions and other financial institutions as well as their officers and employees.
Enforcement: Increased enforcement and tougher sanctions for appraisers are proposed as major components of the solution for appraiser fraud and appraisal inflation. Resources for filing complaints against the perpetrators of appraisal and mortgage fraud are listed at www.wra.org/fraud.
Consumer education: First-time homebuyers and homebuyers with no credit history or a marginal credit standing should be urged to attend credit counseling or homebuyer counseling classes. Buyers who are educated about the basics of consumer credit, mortgage loans and homeownership are less likely to fall prey to unscrupulous lenders or to unrealistically overextend their financial resources. Visit www.wra.org/LoanAssist for consumer resources addressing consumer credit, mortgage loans and the home-buying process.
Conclusion: Clearly, the problem of appraisal fraud is not just about some crooked appraisers not doing their jobs properly. The problem is complex, an apparent by-product of a system where most of the players who interface with appraisers are paid based upon the sales price, loan amount and ultimate success of purchase transactions. If unbiased, objective appraisals are the goal, appraisers must be able to work independently in an environment free from coercion and undue pressure. There is no easy answer and any resolution may require reforms throughout the real estate lending process.