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The Importance of Appraisals in a Declining Market

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By Jason Kotar

RISMEDIA, Jan. 10, 2008-Remember when home values were steadily increasing and financing for home ownership had few restrictions or hurdles? Well, as you know that environment has significantly changed and is continuing to evolve as both government and financial markets are attempting to deal with the credit situation.

Along with this, the Comparative Market Analysis (CMA) is taking on more importance. In addition to establishing a relative asking price or market value of properties in an area, the CMA actually impacts how the loan approval process might proceed after the offer is accepted.

Until recently, the CMA was almost an afterthought for many real estate professionals; something that could literally be done on the way to a listing appointment. The comparables of existing home sales were easy to do since so many were within the same subdivision and almost all were within a 90 day window.

The past several years had seen an incredible spike in not only home sales but also home prices. Recently, as home prices have declined along with home sales, how real estate professionals look at CMA’s going forward will impact our market more than ever imagined. Consider the following scenario that many people face on a daily basis in the United States:

Enthusiastic buyers, after weeks or months of looking for just the right home, agree to purchase a home with a sales price of $200,000; and, it has an appraisal (by an independent third-party licensed appraiser) to support that same value of $200,000. The buyers then complete a loan application and figure they should easily qualify for a mortgage loan with income of both husband and wife along with a near perfect credit score of 800. After they submit all the paperwork they are informed by their mortgage loan consultant that the lender has cut the “market” value of their home to $185,000 and that they will require more proof (along with the possibility of a second appraisal) from the appraiser to support the $200,000 sale price. The purchase transaction now has a potential shortfall of $15,000 and may require the buyer and seller to renegotiate on the price.

Unusual? Hardly. This is becoming more and more common as many lenders are using their in-house appraiser or an Automated Valuation Model (AVM) before the loan is even underwritten for approval. An AVM is a purchased service that some lenders utilize to provide property valuations using mathematical modeling combined with a database. AVM’s calculate a property’s estimated value at a specific point in time by analyzing values of comparable properties. The biggest drawback to this method is that a physical inspection of the property does not occur.

Many lenders are using their in-house appraiser or an AVM as an initial validation of the independent appraisal. If the difference between the two appraisals is greater than a certain percentage the lender will often require a second, independent appraisal to settle the issue.

As a licensed mortgage broker that has been in the business before the “purchase/refinance boom” of the previous five years began, I am quite aware of how the major lenders analyze appraisals. However, to give some broader focus to this issue, I surveyed over 20 lenders and put together the following guidelines that lenders are generally using when evaluating a mortgage.

These guidelines are not intended to be all inclusive and may differ depending on the lender. They should be viewed as the minimum requirements used to set the market value by using data for comparable properties.

- Must be within a three to six month period, with similar features such as square footage.
- Must provide days on market for the subject property and comparable sales used.
- Must be within close proximity of the subject property, looking at neighborhood character as well (urban, suburban or rural).
- Must be within a one mile radius of the subject.
- Must provide one current listing or pending sale from the Multiple Listing Service to help support value.

If any of these guidelines cannot be positively addressed or supported in the appraisal, the appraiser needs to provide a detailed written explanation of the circumstances.

In the past, choosing an appraiser and a mortgage lender were mutually exclusive activities, one performed by the real estate agent, the other by the mortgage broker. In today’s environment, a collaborative effort between the real estate and mortgage professionals makes sense when it comes to choosing an appraiser. As a way to potentially minimize these issues before the file is submitted to a lender for approval, the mortgage broker should determine if the lender has a list of approved appraisers that they recommend or get a list of their specific requirements.

It is incumbent that all parties, from the real estate professional to the mortgage broker to the appraiser, to be aware of the constantly changing requirements of lenders regarding appraisals.

Jason Kotar is president of Diversity Lending Group, Inc.

For more information, visit http://www.diversitylg.com/.

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