Residential Appraisals: Opportunities to Enhance Oversight of an Evolving Industry
Published: 2011-07-13T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Real estate valuations, which encompass appraisals and other estimation methods, have come under increased scrutiny in the wake of the recent mortgage crisis. The Dodd- Frank Wall Street Reform and Consumer Protection Act (the Act) mandated that GAO study the various valuation methods and the options available for selecting appraisers, as well as the Home Valuation Code of Conduct (HVCC), which established appraiser independence requirements for mortgages sold to Fannie Mae and Freddie Mac (the enterprises). GAO examined (1) the use of different valuation methods, (2) factors affecting consumer costs for appraisals and appraisal disclosure requirements, and (3) conflict-of-interest and appraiser selection policies and views on their impact. To address these objectives, GAO analyzed government and industry data; reviewed academic and industry literature; examined federal policies and regulations, professional standards, and internal policies and procedures of lenders and appraisal management companies (AMC); and interviewed a broad range of industry participants and observers..
section_title: What GAO Found
paragraphs: Data GAO obtained from the enterprises and five of the largest mortgage lenders indicate that appraisals--which provide an estimate of market value at a point in time--are the most commonly used valuation method for first-lien residential mortgage originations, reflecting their perceived advantages relative to other methods. Other methods, such as broker price opinions and automated valuation models, are quicker and less costly but are viewed as less reliable and therefore generally are not used for most purchase and refinance mortgage originations. Although the enterprises and lenders GAO spoke with do not capture data on the prevalence of approaches used to perform appraisals, the sales comparison approach--in which the value is based on recent sales of similar properties--is required by the enterprises and the Federal Housing Administration and is reportedly used in nearly all appraisals. Recent policy changes may affect consumer costs for appraisals, while other policy changes have enhanced disclosures to consumers. Consumer costs for appraisals vary by geographic location, appraisal type, and complexity. However, the impact of recent policy changes on these costs is uncertain. Some appraisers are concerned that the fees they receive from AMCs--firms that manage the appraisal process on behalf of lenders--are too low. A new requirement to pay appraisers a customary and reasonable fee could affect consumer costs and appraisal quality, depending on how new rules are implemented. Other recent policy changes aim to provide lenders with a greater incentive to estimate costs accurately and require lenders to provide consumers with a copy of the valuation report prior to closing. Conflict-of-interest policies, including HVCC, have changed appraiser selection processes and the appraisal industry more broadly, which has raised concerns among some industry participants about the oversight of AMCs. Recently issued policies that reinforce prior requirements and guidance restrict who can select appraisers and prohibit coercing appraisers. In response to market changes and these requirements, some lenders turned to AMCs to select appraisers. Greater use of AMCs has raised questions about oversight of these firms and their impact on appraisal quality. Federal regulators and the enterprises said they hold lenders responsible for ensuring that AMCs' policies and practices meet their requirements for appraiser selection, appraisal review, and reviewer qualifications but that they generally do not directly examine AMCs' operations. Some industry participants said they are concerned that some AMCs may prioritize low costs and speed over quality and competence. The Act places the supervision of AMCs with state appraiser licensing boards and requires the federal banking regulators, the Federal Housing Finance Agency, and the Bureau of Consumer Financial Protection to establish minimum standards for states to apply in registering AMCs. A number of states began regulating AMCs in 2009, but the regulatory requirements vary. Setting minimum standards that address key functions AMCs perform on behalf of lenders would enhance oversight of appraisal services and provide greater assurance to lenders, the enterprises, and others of the credibility and quality of the appraisals provided by AMCs.
section_title: What GAO Recommends
paragraphs: GAO recommends that federal banking regulators, the Federal Housing Finance Agency (FHFA), and the Bureau of Consumer Financial Protection consider addressing several key areas, including criteria for selecting appraisers, as part of their joint rulemaking under the Act to set minimum standards for states to apply in registering AMCs. The federal banking regulators and FHFA agreed with or indicated they would consider the recommendation.

section_title: Letter
paragraphs: Real estate valuations, which encompass appraisals and other value  estimation methods, play a critical role in mortgage underwriting by  providing evidence that the market value of a property is sufficient to help  mitigate losses if the borrower is unable to repay the loan. However,  recent turmoil in the mortgage market raised questions about mortgage  underwriting practices, including the quality and credibility of some  valuations. Some appraisers have reported that, during the mid-2000s,  loan officers and mortgage brokers pressured them to overvalue  properties to help secure mortgage approvals. In 2007, a lawsuit brought  by the New York State Attorney General alleged that a major lender  pressured an appraisal management company (AMC) to select  appraisers who would inflate property values. The investigation into  these allegations led to questions about what the government-sponsored  enterprises Fannie Mae and Freddie Mac (the enterprises), which had  purchased many of the lender’s mortgages, had done to ensure that the  appraisals for the mortgages met the enterprises’ requirements. The  outcome of that investigation was an agreement—between the Attorney  General, the enterprises, and the Federal Housing Finance Agency  (FHFA), which regulates the enterprises—that included the adoption of  the Home Valuation Code of Conduct (HVCC). HVCC sets forth certain  appraiser independence requirements for loans sold to the enterprises.
Although the Dodd-Frank Wall Street Reform and Consumer Protection  Act (Pub. L. No. 111-203) (the Act) declared HVCC no longer in effect, it  codified several of HVCC’s provisions. In addition, the enterprises have  incorporated many of the other provisions into their requirements. This  report responds to a mandate in the Act that directed us to study the  effectiveness and impact of various valuation methods and the options  available for selecting appraisers, as well as the impact of HVCC. As  required by the mandate, we provided you with a status report on our  study in October 2010. Our work focused on valuations of single-family  residential properties for first-lien purchase and refinance mortgages. This  report discusses (1) the use of different valuation methods and their  advantages and disadvantages; (2) policies and other factors that affect  consumer costs and requirements for disclosing appraisal costs and  valuation reports to consumers; and (3) conflict-of-interest and appraiser  selection policies and views on the impact of these policies on industry  stakeholders and appraisal quality. We consider the impact of HVCC  throughout this report.
To address these objectives, we analyzed proprietary data we obtained  from the enterprises, lenders, AMCs, and FNC, Inc. (a mortgage  technology company) on the use of different valuation methods and  appraisal approaches. We tested the reliability of the data used in this  report by conducting reasonableness checks on data elements to identify  any missing, erroneous, or outlying data. We also interviewed enterprise,  lender, AMC, and FNC representatives to discuss the interpretation of  various data fields. We concluded that the data we used were sufficiently  reliable for our purposes. We reviewed academic and industry literature  on the advantages and disadvantages of the different valuation methods  and appraisal approaches. We examined federal regulations and policies,  professional standards published by industry groups, and internal policies  and procedures of lenders and AMCs to understand requirements and  practices for using different valuation methods, selecting appraisers,  ensuring appraiser independence, and disclosing costs and valuation  reports to consumers. Finally, we interviewed a broad range of appraisal  and mortgage industry participants and observers—including  representatives of appraiser groups, lenders, AMCs, and other  participants in the valuation process—to obtain their views on the use of  different methods and options for selecting appraisers, as well as the  impacts of recent policy changes, including HVCC, on industry  participants and appraisal quality. We also discussed these issues with  officials from the federal banking regulatory agencies—the Board of  Governors of the Federal Reserve System (Federal Reserve), the Federal  Deposit Insurance Corporation (FDIC), the National Credit Union  Administration (NCUA), the Office of the Comptroller of the Currency  (OCC), and the Office of Thrift Supervision (OTS)—as well as from the  enterprises, FHFA, and the Department of Housing and Urban  Development’s (HUD) Federal Housing Administration (FHA). Appendix I  contains a more detailed description of our objectives, scope, and  methodology.
We conducted this performance audit from July 2010 to July 2011 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Composition of the Mortgage Market and Lending Channels
paragraphs: The composition of the mortgage market has changed dramatically in  recent years. In the early to mid-2000s, the market segment comprising  nonprime mortgages (e.g., subprime and Alt-A loans) grew rapidly and  peaked in 2006, when it accounted for about 40 percent of the mortgages  originated that year. Many of these mortgages had nontraditional or  riskier features and were bundled by investment banks into private  securities that were bought and sold by investors. The nonprime market  contracted sharply in mid-2007, partly in response to increasing default  and foreclosure rates for these mortgages, and many nonprime lenders  subsequently went out of business. The market segments comprising  mortgages backed by the enterprises and FHA had the opposite  experience: a sharp decline in market share in the early to mid-2000s,  followed by rapid growth beginning in 2007. For example, the  enterprises’ share of the mortgage market decreased from about one-half  in 2003 to about one-third in 2006. By 2009 and 2010, enterprise-backed  mortgages had increased to more than 60 percent of the market.  Similarly, FHA-insured mortgages grew from about 2 percent of the  market in 2006 to about 20 percent in 2009 and 2010.
Lenders originate mortgages through three major channels: mortgage  brokers, loan correspondents, and retail lenders. Mortgage brokers are  independent contractors who originate mortgages for multiple lenders that  underwrite and close the loans. Loan correspondents originate,  underwrite, and close mortgages for sale or transfer to other financial  institutions. Retail lenders originate, underwrite, and close loans without  reliance on brokers or loan correspondents. Large mortgage lenders may  originate loans through one or more channels.
section_title: Appraisals and Other Valuation Methods
paragraphs: Before originating a mortgage loan, a lender assesses the risk of making  the loan through a process called underwriting, in which the lender  generally examines the borrower’s credit history and capacity to pay back  the mortgage and obtains a valuation of the property to be used as  collateral for the loan. (See fig. 1.) Lenders need to know the property’s  market value, which refers to the probable price that a property should  bring in a competitive and open market, in order to provide information for  assessing their potential loss exposure if the borrower defaults. Lenders  also need to know the value in order to calculate the loan-to-value (LTV)  ratio, which represents the proportion of the property’s value being  financed by the mortgage and is an indicator of its risk level.
Real estate can be valued using a number of methods, including  appraisals, broker price opinions (BPO), and automated valuation models  (AVM). An appraisal is an opinion of value based on market research  and analysis as of a specific date. Appraisals are performed by state- licensed or -certified appraisers who are required to follow the Uniform  Standards of Professional Appraisal Practice (USPAP). A BPO is an  estimate of the probable selling price of a particular property prepared by  a real estate broker, agent, or sales person rather than by an appraiser.  BPOs can vary in format and scope, and currently there are no national  standards that brokers are required to abide by in performing BPOs. An  AVM is a computerized model that estimates property values using public  record data, such as tax records and information kept by county  recorders, multiple listing services, and other real estate records. These  models use statistical techniques, such as regression analysis, to  estimate the market values of properties. The enterprises and various  private companies have developed a range of proprietary AVMs.
Lenders have several options open to them for selecting appraisers.  Lenders can select appraisers directly, using either in-house appraisers,  independent appraisers, or appraisal firms that employ appraisers, or they  can use AMCs that subcontract with independent appraisers. AMCs  perform a number of functions for lenders, including identifying qualified  appraisers in different geographic areas, assigning appraisal orders to  appropriate appraisers, following up on appraisal orders, and reviewing  appraisal reports for completeness and quality prior to delivering them to  lenders.
Appraisers consider a property’s value from three points of view—cost,  income, and sales comparison—and provide an opinion of market value  based upon one or more of these appraisal approaches. The cost  approach is based on an estimate of the value of the land plus what it  would cost to replace or reproduce the improvements (e.g., buildings,  landscaping) minus physical, functional, and external depreciation. The  income approach is an estimate of what a prudent investor would pay  based upon the net income the property produces and is of primary  importance in ascertaining the value of income-producing properties,  such as rental properties. The sales comparison approach compares and  contrasts the property under appraisal (subject property) with recent  offerings and sales of similar properties.
The scope of work for an appraisal depends on a number of factors,  including the property type and the requirements of the mortgage lender  or investor. For example, the lender may require the appraiser to provide  an estimate of value using the income approach in addition to the sales  comparison approach for a property that will be rented, or the lender may  request that the appraiser provide a specific number of sales of  comparable properties and properties currently listed for sale to better  understand the subject property’s local market. Appraisals vary in type by  the property being appraised (for example, a single-family home or  condominium unit) and the level of inspection performed (exterior only or  both interior and exterior).
section_title: Federal Oversight of Appraisals
paragraphs: In response to losses the federal government suffered during the savings  and loan crisis of the mid-1980s, Congress enacted the Financial  Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).  Title XI of this statute contains provisions to ensure that certain real  estate-related financial transactions have appraisals that are performed  (1) in writing, in accordance with uniform professional standards, and (2)  by individuals whose competency has been demonstrated and whose  professional conduct is subject to effective supervision. The primary  intent of the appraisal reforms contained in Title XI is to protect federal  deposit insurance funds and promote safe and sound lending. Title XI  also created the Appraisal Subcommittee, which is responsible for  monitoring the implementation of Title XI. The subsequent regulations  implementing FIRREA exempt transactions that have appraisals  conforming to the enterprises’ appraisal standards or that are insured or  guaranteed by a federal agency, such as FHA, the Department of  Veterans Affairs (VA), and the Department of Agriculture (USDA).
The enterprises, whose activities are overseen by FHFA, include  appraisal requirements in the guides they have developed for lenders that  sell mortgage loans to them. These guides identify the responsibilities of  lenders in obtaining appraisals and selecting appraisers, specify the  required documentation and forms for different appraisal types (including  different levels of inspection), and detail the appraisal review processes  lenders must follow. In addition, the enterprises issued appraiser  independence requirements in 2010 that replaced HVCC.
FHA uses appraisals to determine a property’s eligibility for mortgage  insurance. FHA’s appraisal requirements are outlined in a handbook on  valuations and in periodic letters to approved lenders (called mortgagee  letters). FHA requires appraisals to include inspections to assess whether  the property complies with FHA’s minimum property requirements and  standards. Appraisers must be state-certified and must have applied to  FHA to be placed on FHA’s appraiser roster in order to perform  appraisals for FHA-insured loans. Lenders select an appraiser from the  FHA roster. VA and USDA have loan guaranty programs, and USDA also  has a direct loan program, with their own appraisal requirements and  processes. VA’s appraisal process is different from those of FHA and  USDA in that VA assigns an appraiser from its own panel of approved  appraisers and has established a fee schedule that sets a maximum fee  that can be charged to the borrower. USDA does not have a roster of  appraisers or many requirements beyond that lenders must use properly  licensed or certified appraisers.
For mortgages originated by federally regulated institutions but not sold to  the enterprises or insured or guaranteed by a federal agency, Title XI of  FIRREA places responsibility for regulating appraisals and “evaluations”  with the federal banking regulatory agencies. Federal banking regulators  have responsibility for ensuring the safety and soundness of the  institutions they oversee, protecting federal deposit insurance funds,  promoting stability in the financial markets, and enforcing compliance with  applicable consumer protection laws. To achieve these goals, the  regulators conduct on-site examinations to assess the financial condition  of the institutions and monitor their compliance with applicable banking  laws, regulations, and agency guidance. These agencies are OCC, which  oversees federally chartered banks; OTS, which oversees savings  associations (including mortgage operating subsidiaries); NCUA, which  charters and supervises federal credit unions; the Federal Reserve, which  oversees insured state-chartered member banks; and FDIC, which  oversees insured state-chartered banks that are not members of the  Federal Reserve System. Both the Federal Reserve and FDIC share  oversight with the state regulatory authority that chartered the bank. The  Federal Reserve also has general authority over lenders that may be  owned by federally regulated holding companies but are not federally  insured depository institutions.
As required by Title XI, federal banking regulators have established  appraisal and evaluation requirements through regulations and have also  jointly issued Interagency Appraisal and Evaluation Guidelines. These  regulations and guidelines address the minimum appraisal and evaluation  standards lenders must follow when valuing property and specify the  types of policies and procedures lenders should have in place to help  ensure independence and credibility in the valuation process. Among  other things, lenders are required to have risk-focused processes for  determining the level of review for appraisals and evaluations, reporting  lines for collateral valuation staff that are independent from the loan  production function, and internal controls to monitor any third-party  valuation providers. The federal banking regulators have procedures for  examining the real estate lending activities of regulated institutions that  include steps for assessing the completeness, adequacy, and  appropriateness of these institutions’ appraisal and evaluation policies  and procedures.
section_title: Consumer Protection Statutes Relating to Appraisals
paragraphs: Other laws that apply to appraisals for residential mortgages include  consumer protection statutes, such as the Truth in Lending Act (TILA),  which addresses disclosure requirements for consumer credit  transactions and regulates certain lending practices; the Equal Credit  Opportunity Act (ECOA), which addresses non-discrimination in lending;  and the Real Estate Settlement Procedures Act of 1974 (RESPA), which  requires transparency in mortgage closing documents. Regulations  implementing TILA and ECOA are issued by the Federal Reserve and  enforced by the federal banking regulators. RESPA regulations are  issued by HUD and enforced by HUD and the federal banking regulators.  Under the Dodd-Frank Act, most rulemaking authority and some  implementation and enforcement responsibilities for these laws will be  transferred to the Bureau of Consumer Financial Protection to be  established in the Federal Reserve System.
section_title: The Widespread Use of Appraisals and the Sales Comparison Approach Reflect Their Relative Advantages for Valuations in Mortgage Originations
subsections: section_title: Available Data Indicate That Appraisals Are the Most Commonly Used Valuation Method for Mortgage Originations
paragraphs: Available data, lenders, and mortgage industry participants we spoke with  indicate that appraisals are the most frequently used valuation method for  home purchase and refinance mortgages. To determine the use of  valuation methods in mortgage originations, we requested data from the  enterprises and the five lenders with the largest dollar volume of  mortgage originations in 2010. The enterprises provided us with data on  the minimum valuation method and, when applicable, the level of  appraisal inspection they required for the mortgages they purchased from  2006 through 2010 that were underwritten using their automated  underwriting systems. (Because these are minimum requirements,  lenders can and sometimes do exceed them.) The lenders provided us  with data on the actual valuation method and appraisal inspection level  for mortgages they made during the same period, although they did not  always have information for the earlier years or for mortgages originated  through their broker and correspondent lending channels. Because the  enterprise and lender data were more complete for recent years, the  following discussion provides more detail on 2009 and 2010, a period in  which mortgages backed by the enterprises (along with FHA) dominated  the market.
Data for the two enterprises combined show that, for first-lien residential  mortgages, the enterprises required appraisals for    94 percent of mortgages they bought in 2009, including 92 percent of  purchase mortgages and 94 percent of refinance mortgages; and   85 percent of mortgages they bought in 2010, including 86 percent of  purchase mortgages and 84 percent of refinance mortgages.
For the remaining mortgages processed through their automated  underwriting systems, the enterprises did not require an appraisal  because their underwriting analysis indicated that the default risk of the  mortgages was sufficiently low to instead require validation of the sales  prices (or loan amounts in the case of refinances) by an AVM-generated  estimate of value. In both 2009 and 2010, the enterprises required  interior and exterior inspections for roughly 85 percent of the appraisals  for purchase mortgages and roughly 92 percent of the appraisals for  refinance mortgages. The remaining appraisals required exterior  inspections only. Available enterprise data for the preceding 3 years  showed that appraisals were required for almost 90 percent of mortgages  (purchase and refinance transactions combined), and the percentage of  appraisals requiring both interior and exterior inspections increased from  approximately 80 percent to 86 percent, although the data covered a  smaller proportion of the enterprises’ total mortgage purchases.
We also aggregated data from five lenders, which include not only  mortgages sold to the enterprises, but also mortgages insured by FHA,  guaranteed by VA or USDA, held in the lenders’ portfolios, or placed in  private securitizations. These data show that, for the first-lien residential  mortgages for which data were available, these lenders obtained  appraisals for    88 percent of the mortgages they made in 2009, including 98 percent  of purchase mortgages and 84 percent of refinance mortgages; and   91 percent of the mortgages they made in 2010, including 98 percent  of purchase mortgages and 88 percent of refinance mortgages.
For mortgages for which an appraisal was not done, the lenders we  spoke with reported that they generally relied on validation of the sales  price against an AVM-generated value, in accordance with enterprise  policies that permit this practice for some mortgages with characteristics  associated with a lower default risk.
For both 2009 and 2010, the lenders reported that interior and exterior  inspections of the subject property were conducted for over 99 percent of  the appraisals for purchase mortgages and about 97 percent of the  appraisals for refinance mortgages. The remainder involved exterior  inspections only. Although data for the preceding 3 years were less  complete, they showed roughly similar percentages to those for  mortgages made in 2009 and 2010. The higher percentages reported by  the lenders compared with those from the enterprises in 2010 may partly  reflect lender valuation policies that exceed enterprise requirements in  some situations. For example, officials from some lenders told us their  own risk-management policies may require them to obtain an appraisal  even when the enterprises do not, or they may obtain an appraisal to  better ensure that the mortgage complies with requirements for sale to  either of the enterprises. Additionally, FHA requires appraisals with  interior and exterior inspections for all of the purchase mortgages and  most of the refinance mortgages it insures, and most of the lenders we  contacted make substantial numbers of these mortgages.
The enterprises have efforts under way to collect more complete  proprietary data on the use of different valuation methods. In order to  obtain consistent appraisal and loan data for all mortgages they purchase  from lenders, the enterprises are currently undertaking a joint effort, under  the direction of FHFA, called the Uniform Mortgage Data Program  (UMDP). UMDP has two components related to appraisals. The first  component is scheduled to begin September 2011, when appraisers will  be required to use new standardized response options in completing  appraisal report forms. The second component will be a Web-based  portal that will facilitate the delivery of standardized appraisal data to the  enterprises, and the enterprises are planning to fully implement UMDP by  March 2012. According to officials from the enterprises, UMDP will  produce a proprietary dataset that will allow the enterprises to work with  lenders to resolve any concerns regarding appraisal quality prior to  purchasing mortgages. Additionally, officials told us that the dataset  would also allow them to assess the impact of their valuation policies on  appraisal quality and mortgage risk. However, some appraisal industry  stakeholders have expressed concerns that in some circumstances the  standardized response options may be too limited to clearly and  accurately communicate information that is material to the appraisal.
section_title: Valuation Policies and Practices Generally Reflect the Advantages and Disadvantages of Different Methods
paragraphs: The enterprises, FHA, and lenders require and obtain appraisals for most  mortgages because appraising is considered by mortgage industry  participants to be the most credible and reliable valuation method.  According to mortgage industry participants, appraisals have certain  advantages that set them apart from other valuation methods. Most  notably, appraisals and appraisers are subject to specific requirements  and standards. The minimum standards for appraisals included in USPAP  cover both the steps appraisers must take in developing appraisals and  the information the appraisal report must contain. USPAP also requires  that appraisers follow standards for ethical conduct and have the  competence needed for a particular assignment. For example, the  appraiser must be familiar with the specific type of property, the local  market, and geographic area. Furthermore, state licensing and  certification requirements for appraisers include minimum education and  experience criteria and call for successfully completing a state- administered examination. Also, standardized report forms, including  those developed by the enterprises, provide a way to report relevant  appraisal information in a consistent format. However, some of these  potential advantages depend on effective oversight, and we have  previously reported on weaknesses in oversight of the appraisal industry.  For example, in a 2003 report we noted that many state appraiser  regulatory agencies cited resource limitations as an impediment to  carrying out their oversight responsibilities. In addition, as previously  discussed, some appraisal industry participants have reported that some  lenders and mortgage brokers have pressured appraisers to inflate  property values in violation of appraiser independence standards. Even in  the absence of overt pressure, biased appraisal values may result from  the conflict of interest that arises where the appraiser is selected,  retained, or compensated by a person with an interest in the outcome or  dollar amount of the loan transaction.
In contrast with appraisals, BPOs do not have standard requirements and  are generally not considered a credible valuation method for mortgage  originations. According to some mortgage industry participants, a key  disadvantage of BPOs is that real estate brokers and agents who perform  them are not required to obtain training or professional credentials in  property valuation, and the BPO industry lacks uniform standards. At  least one industry group has developed standards of practice for BPOs,  which are reportedly used by some BPO providers, but adherence to  these standards is voluntary. Similarly, the industry has not adopted  standardized BPO forms, resulting in differences in the content and  quality of BPO reports, according to some mortgage industry participants.  Additionally, BPOs provide somewhat different information than  appraisals—a sales price or listing price rather than the property’s market  value. The enterprises do not permit lenders to use BPOs for mortgage  originations, and guidelines from federal banking regulators state that  BPOs do not meet the standards for an evaluation and cannot be used as  the primary basis for determining property values for mortgages  originated by regulated institutions.
Lenders and other mortgage industry participants we spoke with identified  advantages to BPOs that make them useful for property valuations in  situations other than first-lien purchase or refinance mortgage  transactions, such as monitoring the collateral in their existing loan  portfolios and developing loss-mitigation strategies for distressed  properties. In these circumstances, some mortgage industry participants  told us that leveraging real estate brokers’ knowledge of local sales and  listings is an advantage because it helps them determine probable selling  prices. BPOs can be also performed cheaper and faster than appraisals,  which allows lenders to obtain more of them and make decisions more  quickly, particularly when dealing with distressed properties. Lenders and  AMCs we spoke with estimated that BPOs cost from $65 to $125 and are  generally completed in 3 to 5 days, while appraisals can cost more than  twice as much and take several days longer to complete.
AVMs are generally not used as the primary source of information on  property value for first-lien mortgage originations, due in part to potential  limitations with the quality and completeness of the data AVMs use. Data  sources for AVMs include public records, such as tax records and  information kept by county recorders, and multiple listing services.  Assessed values for property tax purposes are not always current and are  themselves often generated from statistical models. Information on  property sales kept by county recorders is not necessarily complete or  consistent because disclosure and data collection methods can vary by  county. Similarly, data from multiple listing services can be fragmented  and inconsistent, in part because real estate professionals enter the data  themselves, which may result in incomplete or inaccurate data.  Incomplete data for a particular geographic area will prevent an AVM from  producing reliable values for properties in those areas. Lenders have to  regularly monitor the accuracy and coverage of multiple AVMs to  determine which ones should be used for properties in various locations.  Some mortgage industry participants also told us that AVMs tend to be  less reliable in areas where properties are not homogeneous—for  example, a neighborhood with houses built at very different times and on  different sized lots (in contrast with a suburban subdivision, which may  have houses built at the same time and in the same style). In addition,  AVMs may not include information on property conditions; rather, they  may assume that all properties are in average condition. While the  enterprises permit lenders to use AVMs for some mortgage originations  (as discussed earlier), guidelines from federal banking regulators state  that AVMs generally do not meet the standards for an evaluation and  cannot be used as the sole basis for determining property values for  mortgages originated by regulated institutions.
Despite these disadvantages, AVMs provide a fast, inexpensive means of  indicating the value of properties in active markets, and the enterprises  and lenders make use of AVMs for a number of purposes. In addition to  their use in a small percentage of mortgage originations, representatives  from the enterprises and some lenders and AMCs told us they use values  generated by AVMs as part of their quality control processes. They said  that when the appraised value varies significantly from the value  generated by an AVM, they conduct additional analysis to examine the  quality of the appraisal. Similar to BPOs, AVMs may also be used to  monitor collateral values in lenders’ existing loan portfolios. Furthermore,  in circumstances where AVMs are appropriate, they offer a number of  advantages over appraisals. AVMs are generally much quicker and  cheaper than appraisals, requiring only a few seconds to generate an  estimate and costing between $5 and $25, according to mortgage  industry participants we spoke with. Also, proponents of AVMs argue that  this technology delivers more objective and consistent appraisal values  than human appraisers, who may value properties differently and may be  subject to conflicts of interest or pressure from lenders to assess a  property at a specific value, as discussed later in this report.
section_title: The Sales Comparison Approach Is Required in Nearly All Appraisals Because It Is Considered Reliable in Most Situations
paragraphs: USPAP requires appraisers to consider which approaches to value—such  as sales comparison, cost, and income—are applicable and necessary to  perform a credible appraisal of a particular property. Appraisers must then  reconcile values produced by the different approaches they use to reach  a value conclusion. The enterprises and FHA require that appraisals  provide an estimate of market value at a point in time and reflect  prevailing economic and housing market conditions. They require that, at  a minimum, appraisers use the sales comparison approach for all  appraisals because it is considered most applicable for estimating market  value in typical mortgage transactions. They also require appraisers to  use the cost approach for manufactured homes but do not require the  income approach for one-unit properties unless the appraiser deems it  necessary. Consistent with these policies, valuation data we obtained  from FNC suggest that appraisers use the sales comparison approach in  a large majority of mortgage transactions, while the cost approach is used  less often—generally in conjunction with the sales comparison  approach—and the income approach is rarely used. FNC captures data  on appraisals conducted for a number of major lenders; FNC’s data  represent approximately 20 percent of mortgage originations in 2010.  FNC’s data for both purchase and refinance transactions show the  following:    Nearly 100 percent of appraisals from 2010 used the sales  comparison approach. The percentage was the same for 2009  appraisals.   Sixty-six percent of appraisals from 2010 used the cost approach,  generally in combination with the sales comparison approach, similar  to 65 percent for 2009 appraisals.   Five percent of appraisals from 2010 used the income approach,  virtually always in combination with one or both of the other  approaches. The corresponding percentage for 2009 appraisals was   4 percent.
These percentages were roughly similar for purchase and refinance  mortgages. In addition, although FNC’s data for the preceding 3 years  covered a smaller proportion of total mortgages, the percentages for  purchase and refinance transactions combined were generally  comparable to those described above.
Because the sales comparison approach involves an analysis of recent  sales of similar properties, it is generally viewed as the most appropriate  way to estimate market value in active residential markets, according to  industry guidance and research literature. When appraisers use the sales  comparison approach, they find recent sales of comparable properties  and make adjustments to the selling prices of those properties based on  any differences between them and the subject property to estimate  market value. In selecting comparable properties, appraisers often  consider locational attributes (including, but not limited to, distance from  the subject property), which may be critical to a property’s value.  Properties used for comparison should also have been sold relatively  recently to reflect the current market. However, one criticism of the sales  comparison approach is that it may perpetuate price trends in overheated  (or depressed) markets. For example, the use of comparable sales with  inflated sales prices (driven up by factors that increase consumer  demand, such as expanded credit availability) can lead to progressively  higher market valuations for other properties, which in turn become  comparables for future sales transactions. Also, in markets where there  are few recent sales of comparable properties, there may be insufficient  information to support a credible estimate of value.
The second approach to value—the cost approach—is mostly used in  addition to the sales comparison approach, and in specific circumstances,  such as valuing newly constructed properties or manufactured homes,  according to federal officials and appraisal industry participants. To  implement the cost approach, appraisers must estimate how much it  would cost to build a new or substitute property in place of the subject  property. In addition, they must value other site improvements and the  land and consider accrued depreciation. According to some appraisal  industry participants, some circumstances in which the cost approach can  be particularly useful exist more often in rural areas. These circumstances  include properties with unusual features, such as additional structures or  larger (or smaller) lots than those of otherwise comparable properties.  Using the cost approach can provide additional information to appraisers  to account for these unusual features. Further, the cost approach can be  important in estimating the value of newly constructed homes because  cost and market value are usually more closely related when properties  are new (unless there are economic or functional factors that impact  value). However, the cost approach also has a number of disadvantages.  As a property ages, estimating the appropriate amount of depreciation  becomes more difficult and adds uncertainty to the estimate of value.  Additionally, while a common way to estimate land values is to review  recent sales of vacant lots close to the subject property, such sales may  be rare in many mature residential areas. The cost approach also may  not be appropriate for appraising certain types of properties, such as  high-rise condominium units, which are not built individually but rather as  part of a larger complex, and historic properties, which have value not  fully captured by the cost approach.
The third approach to value used in appraisals is the income approach,  which is an estimate of what a prudent investor would pay based upon a  property’s expected net income (such as from rent). For residential  properties, the income approach is considered most useful when there is  an active rental market for comparable properties. However, in some  residential areas, rental properties are relatively rare, resulting in limited  data on which to base an estimate using the income approach. Even  when data on rents are available, they may not be equivalent. For  example, some rent amounts may include the cost of utilities or other  amenities, while others may not. In addition, some lenders told us that the  income approach is often not applicable when the intended use of the  subject property is as an owner-occupied home rather than as an income- producing property.
Some mortgage industry stakeholders have argued that wider use of  other approaches—particularly the cost approach—could help mitigate  what they view as a limitation of the sales comparison approach. They  told us that reliance on the sales comparison approach alone can lead to  unsustainable market values and that using the cost approach as a check  on the sales comparison approach could help lenders and appraisers  identify when this is happening. For example, they pointed to a growing  gap between the average market values and average replacement costs  of properties as the housing bubble developed in the early to mid-2000s.  However, the industry data discussed previously suggest that the cost  approach was used in a substantial proportion of mortgage originations in  recent years. In addition, other mortgage industry participants noted that  a rigorous application of the cost approach may not generate values  much different from values generated using the sales comparison  approach. They indicated, for example, that components of the cost  approach—such as land value or profit margins of real estate  developers—can grow rapidly in housing markets where sales prices are  increasing.
Additional information would be needed to assess any differences  between the values appraisers generated using the different approaches.  Although the available data on appraisal approaches did not include this  information, enterprise officials told us that the UMDP initiative will  capture data on appraisal approaches and values generated by these  approaches, which may help them perform more in-depth analysis of  appraisals for the mortgages they purchase. However, given uncertainty  regarding the future role of the enterprises in the mortgage market and  the proprietary nature of the effort, the degree to which data from the  UMDP initiative will benefit the broader market is unclear. FHFA officials  told us that UMDP could be a potentially important risk management tool  for the enterprises and that they have not made decisions about whether  they will make any of the data collected through the program available for  wider use.
section_title: Recent Policy Changes May Affect Consumer Costs for Appraisals, while Other Policy Changes Have Enhanced Disclosures to Consumers
subsections: section_title: Consumer Costs for Appraisals Vary by Geographic Location, Appraisal Type, and Property Complexity
paragraphs: Lenders generally require consumers to pay for costs associated with  obtaining appraisals, which can include fees paid to appraisers and  appraisal firms for providing the appraisal and fees charged by AMCs that  lenders often use to administer the appraisal process. Mortgage and  appraisal industry participants we spoke with estimated that, for a  conventional mortgage, consumers pay an average of $300 to $450 for a  typical appraisal with an interior and exterior inspection, depending on  where the property is located. Appraisals for properties in high cost-of- living areas and rural areas tend to be more expensive than in low cost- of-living areas and urban areas, according to mortgage industry  participants and available documentation. Some of these differences are  evident—for example, in the VA’s appraiser fee schedule, which shows  variation in fees by state ranging from a low of $325 in Kentucky to a high  of $625 in Alaska. Industry fee information published in February 2010 by  a real estate technology company shows similar state-level variation, with  median fees ranging from $300 to $600. According to this company’s  data, appraisal fees also vary substantially within states, sometimes by  more than $200.
Other factors that affect appraisal costs include the type of appraisal  product (e.g., level of inspection, scope of work) and the size and  complexity of the property, according to appraisers, lenders, and AMCs  we spoke with. For example, one lender said an appraisal with an  exterior-only inspection for a conventional mortgage may cost $100 to  $150 less than an appraisal that also has an interior inspection. Others  told us that an appraisal for an FHA-insured mortgage, which has  additional inspection requirements, might cost $75 more than an  appraisal for a conventional mortgage. Complex properties may require  specialized experience or training on the part of the appraiser and may  require the appraiser to take more time to gather and analyze data to  produce a credible appraisal. A complex property may have unique  characteristics that are more difficult to value, such as being much larger  than nearby properties or being a lakefront or oceanfront property,  because there are likely few properties with comparable features that  have recently been sold. As a result, appraisal costs are often higher for  these properties and would be passed on to the consumer. In addition,  the extent to which data on comparable sales are readily available and  the number of comparables required by the lender may affect appraisal  costs.
Appraisers, lenders, and AMCs we spoke with told us that, in general,  neither the number of appraisal approaches (i.e., sales comparison, cost,  and income) used by an appraiser nor a lender’s use of an AMC affect  consumer costs for an appraisal. USPAP requires appraisers to use as  many of the three approaches as are applicable for each property. While  using multiple approaches requires additional time and effort on the part  of the appraiser, appraisers typically do not adjust their fees on this basis,  according to appraisers we spoke with. Instead, to the extent they are  able to set their fees, they will do so at a level that will cover their total  time and effort across all their assignments, including those requiring  multiple approaches. Similarly, mortgage industry participants we spoke  with told us that the amount a consumer pays for an appraisal is generally  not affected by whether the lender uses an AMC or engages an appraiser  directly. Rather, they said that AMCs typically charge lenders about the  same amount that independent fee appraisers would charge lenders  when working with them directly, and lenders generally pass on the entire  cost to consumers. Appraisers have reported receiving lower fees when  working with AMCs compared to when working directly with lenders  because AMCs keep a portion of the total fee. Appraisal industry  participants told us that the AMC portion is at least 30 percent of the fee  the consumer pays for an appraisal. For example, one AMC official told  us that, for a $375 appraisal, the appraiser would receive approximately  $250, and the AMC would keep $125, $100 of which would cover its costs  and $25 of which would be pretax profit.
According to lenders and AMCs we spoke with, consumer costs for  appraisals increased slightly in 2009, as a result of the enterprises  requiring appraisers to complete an additional form, called the market  conditions addendum. This form prompts appraisers to report on market  conditions and trends in the subject property’s neighborhood, including  housing supply, sales price and listing price trends, seller concessions,  and foreclosure sales. Lenders and AMCs we spoke with estimated that  having appraisers complete the market conditions addendum added  between $15 and $45 to the cost of an appraisal. VA also adopted this  form and added $50 to the fees on its fee schedule.
In general, however, lenders, AMC officials, appraisers, and other  industry participants noted that consumer costs for appraisals have  remained relatively stable in the past several years and pointed to several  factors that could explain this stability. First, a number of those we spoke  with said that increased use of technology and greater availability of data  electronically has allowed appraisers to complete some of their required  tasks more quickly. Second, the supply of appraisers relative to the  demand for their services has helped to hold consumer costs steady.  Some lender and AMC officials said that there is an oversupply of  appraisers in some markets where fewer mortgage loans are being  originated, which has put downward pressure on appraisers’ fees. Third,  AMCs compete with each other for lenders’ business, which keeps costs  relatively stable.
section_title: How the New Requirement That Appraisers Be Paid Customary and Reasonable Fees Will Affect Consumer Costs Is Unknown
paragraphs: A provision in the Act that requires lenders to pay appraisers a  “customary and reasonable fee” may affect consumer costs for  appraisals, depending on interpretation and implementation of federal  rules. The Federal Reserve issued rules in October 2010 outlining two  “presumptions of compliance” for lenders and their agents, such as  AMCs, to demonstrate they are meeting the Act’s requirements.  Compliance with these rules became mandatory on April 1, 2011. Under  the rules, lenders and AMCs are presumed to be in compliance with  customary and reasonable fee requirements if they pay appraisers an  amount reasonably related to recent rates of compensation for  comparable appraisal services performed in a given geographical market  and make adjustments for the specific circumstances of each assignment  (including the type of property, scope of work, and appraiser  qualifications). Alternatively, lenders and AMCs are presumed to comply  with these rules if they set fees by relying on objective third-party  information, such as fee schedules, studies, and surveys prepared by  independent third parties, including government agencies, academic  institutions, and private research firms. According to the Act, these third- party studies cannot include fees paid to appraisers by AMCs. However,  a person may rebut either presumption with evidence that the fee for a  given transaction is not customary and reasonable based on other  information.
The effect of this change on consumer costs may depend on the  approach lenders and AMCs take in complying. Some lenders and AMCs  told us that, under the first presumption of compliance, they believe they  can continue to compensate appraisers at the rates they have been  paying them for recent assignments, relying in part on internal data from  the previous 12 months as evidence that those fees are customary and  reasonable. Assuming they were able to meet the conditions for this  presumption of compliance, consumer costs likely would not change,  according to representatives of these companies. However, other lenders  are taking steps to meet the requirement under the second presumption  of compliance. Some mortgage industry participants told us that some  lenders, including smaller ones, may set appraiser fees at the level  outlined in the VA appraiser fee schedule, which uses information from  periodic surveys of lenders to set maximum fees that borrowers can be  charged in each state. Other lenders and industry groups are having fee  studies done in order to comply. Because these studies cannot include  the fees AMCs pay to appraisers, some industry participants, including  some AMC officials, expect them to demonstrate that appraiser fees  should be higher than what AMCs are currently paying. If that is the case,  these lenders would require AMCs to increase the fees they pay to  appraisers to a rate consistent with the findings of those studies. The  expected result would be an increase in appraisal costs for consumers,  as well as potential improvements in appraisal quality. However, some  lenders are evaluating the possibility of no longer using AMCs and  managing their own panels of appraisers, which would eliminate the AMC  administration fee from the appraisal fee that consumers pay. Some  regulatory officials and lenders told us that lenders can still recover the  cost of managing the appraisal process from the consumer in other  ways—for example, through higher application fees, origination fees, or  interest rates.
FHA instituted a policy requiring lenders to pay reasonable and  customary fees to appraisers in 1997. Initially, this policy required that  lenders charge consumers only the actual amount paid to the appraiser  but was changed several months later to allow lenders to have  consumers pay costs associated with services provided by AMCs, as well  as the fee paid to the appraiser. FHA limited the total costs to consumers  to the amount that was customary and reasonable for an appraisal in the  market area in which the appraisal was performed. In 2009, FHA released  additional guidance on fee requirements, stating that appraisers must be  compensated at a rate that is customary and reasonable for an appraisal  performed in the market area of the property and that AMC fees must not  exceed what is customary and reasonable for the appraisal management  services they provide. FHA’s guidance places responsibility with the  lender for knowing what is customary and reasonable in the areas in  which they lend and advises appraisers not to accept assignments for  which they believe the fees are not reasonable. FHA officials told us they  did not know whether or how this change had affected consumer costs.
section_title: Policy Changes Limit Costs to Consumers Relative to Disclosed Cost Estimates and Require That the Valuation Report Be Disclosed to Consumers Prior to Closing
paragraphs: RESPA requires that lenders disclose estimated appraisal costs to the  consumer along with estimates of other services that are required in order  to close the mortgage loan. These estimates, which are included on a  standard good faith estimate form, must be provided within 3 days of  receiving the consumer’s application for a mortgage loan, unless the  lender turns down the application or the consumer withdraws the  application. Appraisals typically fall in the category of third-party  settlement services required and selected by the lender. In the estimate  provided to the consumer, the lender must identify each third-party  settlement service required, along with the estimated price to be paid by  the consumer to the provider of each service. Subsequently, at loan  closing, the lender must disclose the actual costs for these services on  the HUD-1 settlement form.
Changes to RESPA that took effect in 2010 require that actual costs paid  by consumers for third-party settlement services not exceed estimated  costs by more than 10 percent. If actual costs are higher than this  threshold, the lender is responsible for making up the difference,  providing lenders with a greater incentive to estimate costs accurately.  For each service, the lender is to disclose the name of the third-party  service provider and the amount they were paid. For example, according  to HUD guidance, when a lender uses an AMC to engage an appraiser,  the lender is required to disclose the name of the AMC and the total  amount paid to the AMC (but not how much the AMC paid the appraiser).  When a lender engages an appraiser directly, the lender must disclose  the name of the appraiser and how much the appraiser was paid. The Act  permits, but does not require, lenders to disclose to the consumer  separately the fee paid to the appraiser by an AMC and the administration  fee charged by the AMC at closing. Some appraisers and federal and  state regulatory officials said requiring separate disclosures of AMC fees  and appraiser fees would benefit consumers by providing greater  transparency. However, other federal officials and lenders questioned the  value of separate disclosures for various reasons: the information could  be confusing to consumers, would come too late to inform consumer  decision making if provided at closing, and involves a small part of total  closing costs.
Regulations implementing ECOA require lenders to notify consumers of  their right to receive the valuation report associated with a mortgage  transaction and to provide it upon request. Alternatively, lenders can  routinely provide consumers with a copy of the report during the mortgage  origination process. The Act amended ECOA to require lenders to  provide consumers with a copy of the valuation report no later than 3  days prior to loan closing for first-lien mortgages secured by the  consumer’s principal dwelling and for all types of valuations, including  appraisals, BPOs, and AVMs. In 2009, the enterprises had adopted a  similar requirement as part of HVCC for appraisal reports associated with  mortgages to be sold to the enterprises. These policy changes enhance  disclosures to consumers by guaranteeing they receive information about  the value of the property prior to completing their mortgage transaction.
section_title: Conflict-of-Interest Policies Have Changed Appraiser Selection Processes, with Implications for Appraisal Oversight
subsections: section_title: Recent Policies Address Conflicts of Interest by Enhancing Appraiser Independence Requirements
paragraphs: Recently issued policies reinforce long-standing requirements and  guidance addressing conflicts of interest that may arise when parties  have an incentive to unduly influence or pressure appraisers to provide  biased values. Conflicts of interest arise when direct or indirect personal  interests bias appraisers from exercising their independent professional  judgment. These conflicts can arise in several ways. Loan production staff  and mortgage brokers are often compensated on a commission based  upon mortgage originations, which may give them an incentive to  pressure appraisers to provide values that will allow loans to close. When  lenders order appraisals from an AMC they own or are affiliated with, the  lender’s loan production staff may be able to influence AMC staff to  pressure appraisers, according to some mortgage industry stakeholders.  Companies that provide both valuation services and title services for the  same transaction may also have a potential conflict of interest because  the company stands to profit if the mortgage is approved and the  borrower subsequently purchases the company’s title insurance at  closing. Real estate agents earn commissions based on a property’s  sales price, which may give agents an incentive to influence an  appraiser’s opinion of value. Borrowers may also want to influence  appraisers to provide a value that will allow their loans to be approved.  Some appraisers may acquiesce to these different sources of pressure  because they want to satisfy their clients, receive future assignments, or  do not want to be responsible for stopping the property transaction from  going through.
In order to keep appraisers independent and prevent them from being  pressured, the federal banking regulators, enterprises, FHA, and other  agencies have regulations and policies governing the selection of,  communications with, and coercion of appraisers. Examples of recently  issued policies that address appraiser independence include HVCC,  which took effect in May 2009; the enterprises’ new appraiser  independence requirements that replaced HVCC in October 2010; and  revised Interagency Appraisal and Evaluation Guidelines from the federal  banking regulators, which were issued in December 2010 and apply to  federally regulated financial institutions. Additionally, the Act broadly  prohibits conflicts of interest in the valuation process for all consumer  credit transactions secured by a consumer’s principal dwelling. Provisions  of these and other policies address some or all of the following issues:    Prohibitions against loan production staff involvement in appraiser  selection and supervision. Loan production staff are prohibited from  selecting, retaining, recommending, or influencing the selection of an  appraiser for a specific assignment. The reporting structure for  appraisers must also be independent of the loan production function.  A version of these requirements has been included in the federal  banking regulators’ appraisal regulations since 1990 and in FHA  guidance since 1994. Similar prohibitions were included in HVCC for  loans sold to the enterprises and remain in effect in the enterprises’  current appraiser independence requirements. For VA-guaranteed  loans, VA assigns appraisers on a rotational basis on behalf of  lenders, removing loan production staff and mortgage brokers from  the process altogether.   Prohibitions against third parties selecting appraisers. Appraisers  should be selected by the lender or its agent rather than by a third  party with an interest in the mortgage transaction. The federal banking  regulators include this requirement in their appraisal regulations. In  addition, the enterprises expressly prohibit borrowers from selecting  and retaining appraisers. The enterprises and FHA also prohibit real  estate agents and mortgage brokers from selecting appraisers.   Limits on communications with appraisers. While certain  communications between loan production staff and appraisers are  necessary, other communications that may unduly influence  appraisers are inappropriate. For example, according to the federal  banking regulators’ guidelines, this includes communicating a  predetermined, expected, or qualifying estimate of value or a loan  amount, or a target LTV ratio, to an appraiser. Similarly, the  enterprises and FHA prohibit loan production staff from  communicating with appraisers or AMCs about anything that relates to  or impacts valuation. All of these requirements and guidelines permit  lenders to request that an appraiser (1) consider additional property  information, including additional comparable properties; (2) provide  further detail, substantiation, or explanation of the value conclusion; or  (3) correct errors in the appraisal report. VA permits lenders’ staff to  communicate with appraisers about the timeliness of an appraisal  report, but only VA-approved appraisal reviewers may discuss  valuation matters with the appraiser.   Prohibitions against coercive behaviors. Coercive behavior is intended  to influence appraisers to base property value on factors other than  the person’s independent judgment. The federal banking regulators’  guidelines state that no lender or person acting on a lender’s behalf  should engage in coercive actions, and the enterprises and FHA  expressly prohibit such actions. Examples of coercive actions include  withholding timely payment or partial payment for an appraisal report;  expressly or implicitly promising future business, promotions, or  increased compensation to an appraiser; and implying to an appraiser  that his or her current or future retention depends on the valuation  estimate.
section_title: A Number of Factors, Including HVCC, Increased the Use of Appraisal Management Companies and Changed How Other Industry Participants Operate
paragraphs: Although industry-wide data on lenders’ use of AMCs over time are  unavailable, appraisal industry participants told us that between 60 and  80 percent of appraisals are currently ordered through AMCs, compared  with less than half before HVCC went into effect in 2009. According to  these participants, this increased demand for AMCs’ services has  resulted in a proliferation of new AMCs across the country. Lenders and  other mortgage industry participants identified several factors that have  contributed to a greater use of AMCs. First, market conditions, including  an increase in the number of mortgages originated during the mid-2000s,  put pressure on lenders’ capacity to manage appraiser panels. Second,  as lenders expanded the areas in which they originated mortgages, they  found identifying appraisers with the appropriate experience and  familiarity with the various locations to be increasingly burdensome. They  also said it would be difficult to predict where across the country they  would need appraisers at any given time. AMCs provided a practical  solution to these two issues. According to a number of lenders we spoke  with, AMCs can manage the valuation process and costs more efficiently  than their internal valuation departments. In particular, they told us that  AMCs are better equipped to handle the administrative effort of managing  appraiser panels, such as checking licenses, maintaining contact  information, placing and following up on appraisal orders, performing  initial quality control, and providing national geographic coverage. In  several of these cases, the lenders had already switched to using AMCs  years before HVCC went into effect. The third factor that affected some  lenders’ use of AMCs was that HVCC required additional layers of  separation between loan production staff and appraisers. According to  some appraisal industry participants, some lenders may have outsourced  appraisal functions to AMCs because they thought using AMCs allowed  them to easily demonstrate compliance with the appraiser selection  provisions in HVCC. Several appraisal industry participants told us that  some lenders incorrectly believed they were required to use AMCs in  order to be in compliance with HVCC.
Some appraisers, mortgage brokers, and lenders told us that the  increased use of AMCs and the policy changes that banned mortgage  brokers from selecting appraisers disrupted the business relationships  they relied on and changed the ways they operate. Some of these  industry participants told us small appraisal firms went out of business as  lenders increased their reliance on AMCs. Having lost their lender and  mortgage broker clients, some appraisers said they joined AMC panels to  be able to make a living as appraisers but found they were asked to  perform the same amount of work for less money than they had been  making previously. Some appraisers also indicated that some AMCs  pressure appraisers to complete appraisal reports within unreasonable  time frames or try to guide the appraiser’s value conclusion—for example,  by recommending the use of certain comparable sales. Other appraisal  industry participants told us that some experienced appraisers decided to  perform nonresidential appraisals or left the appraiser profession  altogether instead of working for lower fees. In addition, several lenders  told us they required mortgage brokers to use only designated AMCs—a  change that eliminated the brokers’ ability to communicate with  appraisers. Some mortgage industry participants, including mortgage  brokers, also said that the lack of communication with appraisers caused  delays in receiving appraisals because the brokers had to go through  AMCs to correct reports or have questions answered. In addition,  mortgage brokers we spoke with told us that it may be difficult to transfer  appraisals to another lender if a deal falls through because lenders often  do not accept appraisals that were not from their designated AMCs. In  these instances, a second appraisal would need to be ordered, but at the  borrower’s or mortgage broker’s expense.
section_title: Greater Use of Appraisal Management Companies Highlights Potential Shortcomings in Existing Oversight and Has Raised Questions about Appraisal Quality
paragraphs: Although reliance on AMCs has increased, direct federal oversight of  AMCs is limited. Federal banking regulators’ guidelines for lenders’ own  appraisal functions list standards for appraiser selection, appraisal review,  and reviewer qualifications. For example, a lender’s criteria for selecting  appraisers should identify appraisers who possess the requisite  education, expertise, and experience to competently complete the  assignment. In addition, a lender’s appraisal review policies and  procedures should, among other things, establish a process for resolving  deficiencies in appraisals and set forth documentation standards for the  review. Similarly, the guidelines state that a lender should establish  qualification criteria for appraisal reviewers that take into consideration  education, experience, and competence. The guidelines also require  lenders to establish processes to help ensure these standards are met  when lenders outsource appraisal functions to third parties, such as  AMCs. Officials from the federal banking regulators told us they review  lenders’ policies and controls for overseeing AMCs, including the due  diligence they perform when selecting AMCs, performance expectations  outlined in contracts, and processes for assessing appraisal quality.
However, they told us they generally do not review an AMC’s operations  directly unless they have serious concerns about the AMC, and the lender  is unable to address those concerns. Similarly, the enterprises review  lenders’ policies and controls but not those of AMCs because lenders are  responsible for ensuring that AMCs meet the enterprises’ requirements.  Officials from the enterprises said they do not review AMCs directly  because they do not have business relationships with AMCs.
In light of the growing use of AMCs, a number of states enacted laws  beginning in 2009 to register and regulate AMCs operating within their  jurisdictions, according to officials from several state appraiser regulatory  boards. These officials told us that these laws typically contained several  common elements, including requiring AMCs to have processes in place  for adding appraisers to their panels, reviewing appraisers’ work, and  keeping records of appraisal orders and activities. However, they said  that some states have not adopted such laws, and existing state laws  provide differing levels of oversight. For example, while a number of  states require AMCs to certify that they have the above processes in  place, Utah also requires AMCs to provide a written explanation of those  processes as a condition of registering. Similarly, while some state laws  do not specify requirements for AMC appraisal reviewers, Vermont  requires reviews that address technical aspects of the appraisal to be  performed by appraisers with credentials equal to or greater than the  minimum required to perform the original appraisal assignment.
Some appraiser groups and other appraisal industry participants have  expressed concern that existing oversight may not provide adequate  assurance that AMCs are complying with industry standards and their  own policies and procedures, with negative impacts on appraisal quality.  Although they did not provide us with data to demonstrate a change in  quality, these participants suggested that the practices of some AMCs for  selecting appraisers, reviewing appraisal reports, and establishing  qualifications for appraisal reviewers—key areas addressed in federal  guidelines for lenders’ appraisal functions—may have led to a decline in  appraisal quality:    Selecting appraisers. Appraiser groups said that some AMCs select  appraisers based on who will accept the lowest fee and complete the  appraisal report the fastest rather than on who is the most qualified,  has the appropriate experience, and is familiar with the relevant  neighborhood. They said that, with many experienced appraisers  departing from the industry, less experienced appraisers, who are  often willing to accept lower fees, are left to perform most of the work.   Reviewing appraisal reports. According to some appraisal industry  groups, some AMCs’ appraisal reviews overemphasize how close the  appraiser’s value conclusion is to an expected value generated by an  AVM, at the expense of other important elements of the appraisal,  such as the appropriateness of the comparable sales. One group  noted instances in which AMCs told appraisers which comparable  sales to use when the appraisers’ original value conclusions were not  consistent with AVM-generated values.   Establishing qualifications for appraisal reviewers. Representatives of  an appraisal industry group told us that some AMC reviewers may  lack the expertise necessary to identify problems with quality. They  noted that in some states appraiser licensing and certification  requirements do not address qualifications for appraisal reviewers.
AMC officials we spoke with said that they have processes and standards  that address these areas of concern. Several AMC officials told us they  have vetting processes to select appraisers for their panels, including  minimum requirements for years of appraising experience and education.  When selecting appraisers for a specific assignment, these AMCs  indicated that they use an automated system that identifies the most  qualified appraiser based on criteria such as the requirements for the  assignment, the appraiser’s geographic proximity to the subject property,  and performance metrics such as timeliness and the quality of appraisers’  work. The AMC officials we spoke with said they allow appraisers to  specify how much they will charge for different types of appraisal  assignments and, in some cases, provide appraisers with the range of  fees their peers on the appraiser panel charge. These officials said they  compare fees only when two appraisers are equally qualified for an  assignment, in which case they might default to the appraiser with the  lower fee. Further, these officials said that when performing quality  reviews on appraisals, they run automated checks to identify any  problems with completeness and internal consistency. These reviews  may also involve comparing the appraiser’s estimated value to a value  generated by an AVM. Appraisals flagged for potential problems, such as  risk of overvaluation, are manually reviewed by staff reviewers, who often  have backgrounds in underwriting or appraising. One AMC official told us  that their reviewers also provide coaching for less experienced appraisers  to help them improve the quality of their appraisal reports.
The enterprises and some lenders we spoke with told us that appraisal  quality had improved after HVCC was adopted, although they could not  specifically tie the quality improvements they observed to the use of  AMCs. Some industry participants noted that other market changes that  were occurring at the same time HVCC was implemented could have  contributed to an improvement in appraisal quality, such as the  enterprises’ requirement in 2009 that appraisers also complete the market  conditions addendum form (as previously discussed in connection with its  impact on appraisal costs). Nevertheless, the enterprises told us that  variances between the values in the appraisal reports and values  produced by their proprietary AVMs decreased after HVCC went into  effect—in particular, for mortgages from third-party originators, including  mortgage brokers. In addition, officials from one lender said that once  HVCC went into effect, they required appraisals for mortgages in their  broker channel to be ordered through AMCs and, on the basis of similar  internal metrics that compare AVM-generated values to appraised values,  observed improvements in appraisal quality. Officials from the enterprises  told us that once they have obtained data through UMDP and evaluated  its quality, they may be able to use the data to assess the appraisal  quality of individual AMCs and appraisers.
While views on the impact of AMCs on appraisal quality differ, Congress  recognized the importance of additional AMC oversight in enacting the  Act by requiring each state to register and regulate AMCs and placing the  supervision of AMCs with state appraiser regulatory boards. In addition,  the Act requires the federal banking regulators, along with FHFA and the  Bureau of Consumer Financial Protection, to establish minimum  standards for states to apply when registering AMCs, including  requirements that appraisals coordinated by an AMC comply with USPAP  and be conducted independently and free from inappropriate influence  and coercion. This rulemaking also provides a potential avenue for  reinforcing existing federal requirements for key functions that may impact  appraisal quality, such as selecting appraisers, reviewing appraisals, and  establishing qualifications for appraisal reviewers. Federal guidelines for  lenders address these functions and require that lenders take steps to  ensure that AMCs comply with the guidelines when lenders rely on AMCs  to perform these functions. However, federal regulators do not directly  monitor AMCs’ compliance with the guidelines; direct oversight of AMCs  will be instead performed by state regulators, with the Appraisal  Subcommittee monitoring state AMC oversight. If state standards do not  also address these functions, state oversight of AMCs may not provide  adequate assurance that these functions are being properly carried out.
section_title: Conclusions
paragraphs: Because appraisals provide an estimate of market value at a particular  point in time, they are affected by changes in the housing and mortgage  markets. In recent years, turmoil in these markets has heightened  attention on residential property valuations, and appraisals in particular.  The prominent role of appraisals in the mortgage market underscores the  importance of efforts to better ensure appraisal quality. HVCC, the Act,  and federal banking regulator guidance have sought to address some of  the factors that can affect appraisal quality, including appraiser  independence and compensation. In addition, the enterprises are  undertaking an initiative to collect detailed and standardized appraisal  data that could provide them with greater insight into appraisal practices  for the mortgages they purchase.
Partly in reaction to appraiser independence requirements, lenders have  increasingly relied upon AMCs to perform certain functions. Despite the  increased use of AMCs, direct federal oversight of AMCs is limited  because the focus of regulators is primarily on lenders, and state-level  requirements for AMCs are uneven, ranging from no laws to laws with  specific standards for registering with the state. Some appraisal industry  participants have raised concerns that the management practices of  some AMCs may be negatively affecting appraisal quality. Among the  areas of concern are AMCs’ practices for key functions, including  selecting appraisers for assignments, reviewing completed appraisal  reports, and establishing qualifications for appraisal reviewers. The  federal banking regulators have emphasized the importance of these  functions in guidelines that apply to lenders’ appraisal functions. The Act  requires the federal banking regulators and other federal agencies to set  minimum state standards for registering AMCs, which provides an  opportunity for the regulators to address these areas of concern and  promote more consistent oversight of these functions, whether performed  by lenders or AMCs. Doing so could help to provide greater assurance to  lenders, the enterprises, and federal agencies of the quality of the  appraisals provided by AMCs.
section_title: Recommendation for Executive Action
paragraphs: To help ensure more consistent and effective oversight of the appraisal  industry, we recommend that the heads of FDIC, the Federal Reserve,  FHFA, NCUA, OCC, and the Bureau of Consumer Financial Protection— as part of their joint rulemaking required under the Act—consider  including the following areas when developing minimum standards for  state registration of AMCs: criteria for selecting appraisers for appraisal  orders, review of completed appraisals, and qualifications for appraisal  reviewers.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to FDIC, the Federal Reserve, NCUA,  OCC, and OTS, as well as FHFA, HUD, USDA, and VA, for their review  and comment. We received written comments from the Director of Risk  Management Supervision, FDIC; the Directors of the Divisions of Banking  Supervision and Regulation and Consumer and Community Affairs,  Federal Reserve; the Executive Director of NCUA; the Acting Comptroller  of the Currency; and the Acting Director of FHFA that are reprinted in  appendixes II through VI. We also received technical comments from  FDIC, the Federal Reserve, FHFA, HUD, and OCC, which we  incorporated where appropriate. OTS, USDA, and VA did not provide  comments on the draft report. The Bureau of Consumer Financial  Protection did not receive the draft report in time to provide comments.
In their written comments, the federal banking regulators (FDIC, the  Federal Reserve, NCUA, and OCC) and FHFA agreed with or indicated  they will consider our recommendation to address specific areas as part  of joint rulemaking to develop minimum standards for state registration of  AMCs. In its written response, the Federal Reserve said that it would  consider our recommendation in developing rules to establish minimum  standards. It also cited various regulations and guidance it and other  agencies have issued related to appraiser independence since the 1990s.
While agreeing with our recommendation, OCC noted in its written  comments that improved oversight of AMCs by states does not diminish  federally regulated institutions’ responsibility to ensure that services  performed on their behalf by AMCs comply with applicable laws,  regulations, and guidelines. Finally, FHFA in its written response agreed  that the joint rulemaking process should consider the areas we mention in  our recommendation. While it also noted that the data in the report did not  capture differences between the enterprises’ practices, it noted that the  report discusses that lenders may and do require appraisals beyond what  is required by the enterprises.
We are sending copies of this report to the appropriate congressional  committees, the Chairman of FDIC, the Chairman of the Federal Reserve,  the Acting Director of FHFA, the Secretary of Housing and Urban  Development, the Chairman of NCUA, the Acting Comptroller of the  Currency, the Acting Director of OTS, the Secretary of Agriculture, the  Secretary of Veterans Affairs, the Bureau of Consumer Financial  Protection, and other interested parties. In addition, the report is available  at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff members have any questions about this report, please  contact me at (202) 512-8678 or shearw@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix VII.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This report focuses on valuations of single-family residential properties for  first-lien purchase and refinance mortgages. We examine (1) the use of  different valuation methods and their advantages and disadvantages; (2)  factors that affect consumer costs and requirements for disclosing  appraisal costs and valuation reports to consumers; and (3) conflict-of- interest and appraiser selection policies, and views on the impact of these  policies on industry stakeholders and appraisal quality. We also consider  the impact of the Home Valuation Code of Conduct (HVCC) throughout  the report.
To describe how often different valuation methods are used, we analyzed  valuation data from various sources for mortgages originated in calendar  years 2006 through 2010. We requested aggregated data on valuations  for mortgages originated in these years from Fannie Mae and Freddie  Mac (the enterprises), the five largest lenders (as determined by the  dollar volume of total mortgage originations in 2010), six of the largest  appraisal management companies (AMC) (as identified by industry trade  associations), and three private vendors of mortgage and valuation  technology. In response to our request, we obtained proprietary data from  the enterprises, five lenders (Ally Financial, Inc.; Bank of America, NA;  J.P. Morgan Chase Bank, NA; CitiMortgage, Inc.; and Wells Fargo Bank,  NA), four AMCs (CoreLogic, Landsafe, LSI, and PCV/Murcor), and one  private vendor (FNC, Inc.). Data from each group of entities provide a  partial picture of the valuation methods used in purchase and refinance  mortgage originations and overlap with each other to a certain degree.  The datasets we assembled are unique and therefore difficult to cross- check with other known sources to check their reliability. However, we  were able to corroborate some data elements through interviews, and we  used each of the datasets we assembled and other proprietary data we  obtained to corroborate the other datasets. As a result, we believe that  these data are sufficiently reliable for the purpose of this report, keeping  in mind the following limitations. Because some of the entities compiled  the requested information differently or were reporting information that is  not a part of their normal data collection and retention apparatus, our  datasets contain various degrees of inconsistency, missing data, and  other issues. The data from the enterprises presented in this report only  include mortgages originated using their own automated underwriting  system. As a result, the data do not reflect mortgages that (1) lenders  originated using manual underwriting; (2) lenders originated using their  own, enterprise-approved automated underwriting systems; or (3) were  originated using the automated underwriting system of one enterprise but  purchased by the other enterprise. Data from the lenders often did not  include information on mortgages originated through their broker or  correspondent channels. In addition, data from the early part of the 5-year  period we examined were limited, in part because (according to officials  from some of the lenders) mergers with other financial institutions and  data system changes prevented them from accessing these data. For  these reasons, we have characterized our results in a manner that  minimizes the reliability concerns (e.g., by focusing on 2009 and 2010)  and emphasizes the points on which the data are corroborated. Our  interviews with federal agencies, lenders, AMCs, appraisers, and other  industry stakeholders provided clarification of data elements and  additional perspectives on the use of different valuation methods in  mortgage transactions. Given these and other steps we have taken, we  believe the data are sufficiently reliable for the purposes used in this  study.
The enterprises provided us with data on the minimum valuation method  they required for mortgages they purchased. Table 1 shows the  percentage of total mortgage originations (by dollar volume) that  enterprise purchases accounted for in each of the years we examined.
As previously noted, the data from the enterprises used in this report  cover mortgages that were originated using their automated underwriting  systems and therefore represent only a portion of the total mortgages  they purchased. Table 2 shows the percentage of the enterprises’  mortgage purchases each year that were originated using their  automated underwriting systems, excluding certain refinance mortgages  originated under the Home Affordable Refinance Program.
The five lenders cited previously provided us with data on the valuations  they obtained for mortgages they made. These lenders accounted for  about 64 percent of mortgage originations in 2009 (excluding home equity  loans) and 66 percent in 2010. As discussed earlier, the lender data did  not cover all of their mortgage originations. Table 3 shows the percentage  of each lender’s mortgages for which they provided valuation data.
The four AMCs cited previously provided us with data on the valuations  they provided to lenders. For many appraisals, some AMCs were unable  to identify whether the appraisals were for mortgage originations (as  opposed to other purposes, such as servicing and portfolio management  or removal of mortgage insurance) and, if they were, whether they were  for home purchases or refinancing existing mortgages. In addition, two of  the six AMCs we spoke with did not provide us with data. As a result, the  AMC data we obtained represented a small but undetermined portion of  the mortgage market and were of limited use for purposes other than  corroborating other datasets.
FNC, Inc. is a mortgage technology company that, among other things,  provides software platforms for lenders, appraisers, and other participants  in the mortgage origination process. It captures appraisal data  electronically that pass through its systems and uses the information to  build analytical tools for its clients, which include several national lenders,  as well as various regional and community lenders. The share of the  mortgage market for which FNC captures data has increased over time,  reaching about 20 percent in 2010. We interviewed knowledgeable FNC  officials about their processes and data controls to assess data reliability.
In general, FNC was able to provide us with valuation data for  approximately 80 percent of the appraisals it identified as being for  purchase or refinance mortgages. These data provide some insight into  how often different appraisal approaches are used, though they may not  be representative of the mortgage market as a whole.
To identify the potential advantages and disadvantages of the different  valuation methods, we reviewed relevant research studies and articles  that examine the strengths and limitations of the different valuation  methods and the potential effects on the reliability of appraisals. We also  interviewed representatives from the federal banking regulatory agencies  (the Board of Governors of the Federal Reserve System, the Office of the  Comptroller of the Currency, the Office of Thrift Supervision, the Federal  Deposit Insurance Corporation, and the National Credit Union  Administration), federal agencies with mortgage insurance or guarantee  programs (the Department of Housing and Urban Development’s Federal  Housing Administration, the Department of Veterans Affairs, and the  Department of Agriculture), the enterprises, appraisal industry groups,  AMCs, mortgage lenders (including the five cited previously), mortgage  industry associations (including those representing smaller and rural  lenders), as well as other individual industry stakeholders and  researchers.
To examine the factors that affect appraisal costs, we reviewed federal  and lender policies on fees, including fee schedules. We interviewed the  aforementioned lenders and AMCs and representatives from mortgage  and appraisal industry associations to identify the factors that may affect  valuation costs, including any that may have caused changes in  consumer costs over time. Because our interviews with individual lenders  and AMCs focused on larger companies, the views they expressed may  not be representative of these industries as a whole. To examine  disclosures to consumers, we (1) reviewed and summarized statutes and  policies, such as the Real Estate Settlement Procedures Act, that govern  the disclosure of costs and valuation documentation to consumers and (2)  interviewed federal officials and lenders to ensure our understanding of  these requirements. To assess how HVCC affected appraisal costs and  disclosures, we reviewed the relevant provisions in HVCC; analyzed  information we obtained to identify any changes in costs that may be  attributable to HVCC; and interviewed lenders and appraisers, among  other industry stakeholders.
To determine how federal policies, including HVCC, have addressed  potential conflicts of interest and affected appraiser selection policies, we  reviewed statutes, regulations, guidance, and federal banking regulators’  examination procedures covering appraiser independence requirements.  We interviewed federal banking regulators, lenders, appraisers, AMCs,  state regulatory officials, and other mortgage industry participants to  discuss changes in policies and their impact on the appraisal process,  industry participants, and appraisal quality. In addition, we interviewed the  enterprises, lenders, and AMCs about the policies and procedures they  have in place to assess and help ensure appraisal quality.
We conducted this performance audit from July 2010 to July 2011 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Board of Governors of the Federal Reserve System
section_title: Appendix III: Comments from the Federal Deposit Insurance Corporation
section_title: Appendix IV: Comments from the Office of the Comptroller of the Currency
section_title: Appendix V: Comments from the National Credit Union Administration
section_title: Appendix VI: Comments from the Federal Housing Finance Agency
section_title: Appendix VII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Steve Westley (Assistant  Director), Don Brown, Marquita Campbell, Anar Ladhani, John McGrail,  Marc Molino, Erika Navarro, Jennifer Schwartz, and Andrew Stavisky  made key contributions to this report.