I believe there is a screaming flaw in the mortgage process when it comes to appraisals (but it is not the appraiser’s fault). I never fully understood why this didn’t get more attention when I worked as an appraiser some 7+ years ago, and I especially don’t understand why this hasn’t gotten serious attention after the housing crash, since I believe it is a direct factor in the extent of the losses suffered by the banks. 

Disclaimer: in recent years I have not worked in the real estate business, and I don’t know if things still work exactly the same. I’m not aware of any fundamental shift.

In the mortgage process, it is the loan officer is the one who hires the appraiser in most cases (with the buyer/borrower’s money). The loan officer gets paid a commission when a mortgage loan is closed. They do not lose any money should this loan end up in default later, somewhat in the same way that a car salesman won’t lose money on a car that gets repossessed down the line. They are in effect commission based sales people, with the objective to sell and close loans for the broker or lender. This is usually true for mortgage brokers, and also direct lenders like banks.

Of course there are rules and guidelines to follow, but the fact of the matter is that the motivation of the loan officer is to close loans to earn commissions, plain and simple. Therefore, their interest is to get an appraisal with a number on it that supports the deal so the loan can close. This number is almost always made known to the appraiser (with any sale for example, the appraiser must be given a copy of the sales contract, and analyze it as part of the appraisal).

The result of this dynamic is that the loan officer can exert pressure on the appraiser to hit the magic number they need. Depending on the situation this can be implicitly done, or blatantly explicit; either way, the appraiser knows that his livelihood depends on getting jobs, and getting future jobs depends on keeping the loan officer happy. Even when the loan officer does not purposely wish to influence the appraiser, the implicit pressure is still going to be there as the appraiser knows getting future business depends on closings getting done, and naturally a loan officer prefers an appraiser that helps makes closings happen more than an appraiser with impressive analytical and research skills, and accurate assessments.

The end result is a lot of appraisals with higher valuations than the true value of the property, with of course bigger losses for the lender in the event of foreclosure later, sometimes substantially so. It can also be bad for a home buyer, who ends up borrowing and paying more than the property is really worth (though at times, especially with refi’s, the borrower knowingly pushes for as high a number as they can, so they can pull more cash out of the house).

Please understand that I’m not blaming loan officers for what they do (except in those cases where they blatantly push the appraiser for numbers they know are dishonest and/or are dishonest themselves), they are for the most part only trying to be as successful as they can at their jobs, and earn as much money as they can. It is the process that is flawed.

It is interesting that the lender’s underwriters, whose job it is to protect the lender from risk and make sure the loan is in order and everything is above board, can order a review appraisal (basically another appraiser’s review and verdict on the quality and accuracy of the original appraisal, including its own estimate of value) if they have reason to believe the appraisal is not up to par. If I was a lender that did not want to lose money on foreclosures, I would ALWAYS have the underwriter or handle the appraisal, completely detached and independent from all parties with a stake in the closing.

While I never fully understood this, the best explanation for why lenders do this I have come up with, is simply greed – making as much money as possible off as many loans as possible, many of which are re-sold anyway. But then I still don’t understand why the lenders who end up holding the bag (like the secondary market) allow this situation to exist, even though if I recall correctly Fannie Mae guidelines (which lenders must adhere to if they want to sell the mortgage to the secondary market, like most do) specifically prohibits anyone with a financial interest in the closing to control the hiring of appraisers. Yet it happens all the time.

Anyway, thankfully these days I don’t have to think about this much anymore.