Last week’s column detailed the following benefits from switching from a system of lender-ordered appraisals to a system of borrower-ordered appraisals:

• Borrowers would obtain appraisals before applying for a mortgage, and when the appraised value turned out to be too low, they would spare themselves and the lender the cost of an aborted application.
• The loan process would be shortened, allowing borrowers to use a shorter and cheaper lock period.
• Borrowers would no longer be dissuaded from shopping alternative lenders by the prospect that each application would require an additional appraisal fee.

But there are other issues connected to such a switch, including the important objective of protecting appraisals from pressure exerted by any of the parties with a vested interest in the outcome. This was the major purpose of the Home Valuation Code of Conduct (HVCC), which became effective May 1, 2009, and which has substantially changed the appraisal landscape.

Assuring appraisal independence: The crux of HVCC was an “appraisal independence requirement,” designed to insulate the appraisal process from influence by any of the parties with an interest in the outcome. Mortgage brokers and Realtors could no longer have any contact with appraisers, and lenders had to obtain appraisals in some manner that prevented them from exercising any control. In order to protect themselves from liability, most lenders today order appraisals through appraisal management companies (AMCs).

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The theory was that lenders influenced appraisals through contact with appraisers, and if the AMC stood between them, the process would be clean. But this overlooks that the lender is positioned to direct a continuing stream of clients to the AMC, and won’t do it if the appraisals that come back don’t meet the lender’s expectations. Similarly, the AMC is positioned to direct business to appraisers. If the lender is unhappy with a particular appraiser’s work, the appraiser may no longer get assignments from the AMC.

Part 1: Let borrowers order their own appraisals

Having borrowers purchase appraisals directly from appraisers is not a good idea because borrowers could shop for the appraiser that would do the borrower’s bidding. But in purchasing appraisals through AMCs, borrowers would have very little leverage — much less than lenders because each borrower transaction would be a one-shot deal.

Quality of appraisals: A much-noted feature of the growth of AMCs as intermediaries in the appraisal process is a decline in the quality of appraisals. While some lenders select AMCs on the basis of price and service, lenders that have affiliated business relationships with AMCs direct their business to them. Affiliated AMCs are chosen because the lender shares its revenues, not because the AMC has well-paid appraisers, or appraisers located in proximity to the subject property.

All the major lenders have affiliated business relationships with AMCs. That is why one hears frequently about appraisals being done by appraisers who are not familiar with the local market.

If borrowers ordered appraisals from AMCs, they would select an AMC with local appraisers on their rosters, because AMCs would emphasize this in marketing to consumers. Some AMCs might also disclose what they are paying appraisers, or what amounts to the same thing, what they are retaining for themselves, as a way of emphasizing the quality of their appraisals.

Appraisal fees: Under existing arrangements, AMCs must compete for the business of lenders who refer borrowers to them. Such competition results in higher marketing costs for AMCs, and in revenue splits of affiliated business entities that are favorable to lenders. The result of this kind of competition is higher appraisal fees paid by borrowers. Appraisers, in turn, must compete for the business of AMCs who retain them to do appraisals. The result of this competition is lower fees for appraisers and poorer-quality appraisals. Nobody competes for the borrowers, who pay higher appraisal fees for poorer-quality appraisals.

If borrowers ordered appraisals from AMCs, lenders would be out of the process, and good riddance. AMCs would then have to compete for the patronage of borrowers, which would reduce appraisal fees.

Implementation: It should be public policy to have appraisals ordered by borrowers and have such appraisals accepted by all mortgage lenders. The key to implementing this policy is acceptance by Fannie Mae, Freddie Mac and FHA of appraisals carrying the borrower’s name rather than the lender’s name.

Borrowers who order their own appraisal and require an FHA mortgage will face two special problems, both of which are solvable. Problem one is that FHA will accept appraisals only from FHA-approved appraisers. This means that a borrower who may need an FHA mortgage must inform the AMC that they need an FHA-approved appraiser.

Problem two is that FHA makes it difficult to use the same appraisal twice. It assigns a case number to every application, which is stamped on the appraisal form. This makes the appraisal non-usable by a second lender unless the first lender attests that the borrower was not rejected! Not surprisingly, lenders who are rejected by borrowers are reluctant to assist their competitors, so this rule has the effect of locking FHA borrowers into dealing with the first lender to whom they apply.

But borrowers ordering their own appraisal could defeat this regulatory inanity in a very simple way. When they shop, they provide the lender with a copy of their appraisal but not the original upon which the case number is attached. They hold on to the original until they are prepared to make a commitment.