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. 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). 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.