Home Value Code of Conduct - One Month and Counting

Its been one month since Freddie Mac in a joint agreement with the Federal Housing Finance Agency (FHFA) and the New York State Attorney General enacted a new code of conduct intended, according to the Freddie Mac website, "to enhance the independence and accuracy of the appraisal process, and provide added protections for homebuyers, mortgage investors and the housing market."

The results thus far have been less than stellar. From mortgage brokers to real estate brokers, lenders to appraisers, borrowers to sellers, the HVCC is widely seen minimally as an expensive burden for borrowers to a trap-laden maze of confusion and over regulation by lenders and other real estate professionals.

As with most new laws and regulations the intentions are good. The Code is intended to improve the accuracy of appraisals by eliminating pressure on appraisers from loan officers. Specifically it prohibits direct contact from brokers, agents, or lenders involved in the underwriting of the loan process. Further it removes responsibility of choosing specific appraisers from the lender and places it with designated appraisal management vendors (AVM) who work independently from lenders and brokers.

The code is also intended as protection for borrowers, lenders, and ultimately investors of mortgage backed securities linked to these residential mortgages. This intention is achieved by removing the potential of subjective influence over valuation that had previously weighed heavy on residential appraisers. Within the provisions of the code are restrictions on "providing to an appraiser an anticipated, estimated, encouraged, or desired value for a subject property or a proposed or target amount to be loaned to the borrower." Further, lenders are bound to more responsible duties when ordering a second or follow up appraisal. To do so, they must "adhere to a policy of selecting the most reliable appraisal, rather than the appraisal that states the highest value..."

Yet within these well-intentioned boundaries and objectives lie unintended real life consequences. The first pinch is felt by the borrowers in the form of additional costs to complete appraisal work. According to a Los Angeles Times article last week, borrowers a now finding appraisals costing more for the same work. This includes new "add on" fees like no show penalties and additional add on fees if your home passes a certain dollar value threshold. Lenders too are finding issues with costs. The Code requires the lender to be responsible for the timely payment of an appraisal fee, however the collection of this fee from borrowers is sometimes difficult to get. Borrowers have been reluctant to authorize credit card payments for costs that are unclear to the lender.

Another common practice among prudent lenders and mortgage brokers is to "ball park" a value with an appraiser before a full appraisal is ordered. The intention is not steer value, rather to confirm the borrowers money will be well spent on ordering a full appraisal. If a value cannot be supported and a loan cannot be given this practice saves both time and money. With HVCC this is no longer possible, in fact it is strictly prohibited.

However the most disturbing concerns relating to HVCC are the accountability issues shouldered by appraisers and the negative impact on independent appraisers and their ability to remain financially viable as a business. According to the LA Times, Sacramento-based appraiser James Facchini of American Pacific Appraisal Co. says, "What's terrible is what's happening to [long-established] appraisers who won't work for the low fees" management companies pay." On May 1," Facchini said, "I lost almost my entire customer base."

On the accountability side, few mechanisms are in place to remove unqualified or inaccurate appraisers from the system. Further, lenders are required to randomly select 10% of their appraisal reports for quality control tests and appraisers can be removed or reprimanded for achieving values that are too high. The expected consequence is that appraisers are not affected by conservative or safely low valuations but risk punishment for high values, therefore it drives appraisers towards the lowest values that can be supported.

It's unfortunate that the misconduct prevalent in this last housing boom led to overly cautious regulation in today's market. Further, the industry clearly needs some guidance and regulatory oversight. However simply replacing bad practices with bad policies will not resolve our problems. The HVCC policies are likely to reward appraisers for conservative valuations that inhibit free market movement. Further this policy will ultimately drive experienced entrepreneurial appraisers out of business.

The danger here is that market values will be established by what deals actually fund and close. What gets funded will depend on the appraisal that supports the loans. If appraisals are ordered through large management companies that are driven by volume, they are likely to also price their services accordingly. If more experienced and knowledgeable appraisers can make more money doing something else in the real estate industry they will. The industry will be left with inexperienced appraisers willing to work at discount prices for job security. This is not good.

Then again it's worked out well for the post office and the DMV...

The HVCC applies to all single family and 2-4 unit home loans originated on or after May 1, 2009 intended to be packaged and resold to Fannie Mae or Freddie Mac. The code itself can be found on the Freddie Mac website.