Friday, July 27, 2007

Why does a mortgage require an appraisal?

Young adults who are buying a house for the first time must wonder why an appraisal is even required. Appraisers these days openly ask how much the appraisal needs to be in order to make the deal work and then make sure the appraisal is for that amount. What is the point?

If you are under 30 or so it might surprise you to learn that it used to be in the bank’s interest not to write a mortgage for more than 80% of the house’s true value and not to write a mortgage requiring payments that the borrower could not afford. This was in the days when banks did not sell the mortgages they wrote to third parties and the bank would get the house back if the borrower defaulted. Obviously in those days the bank needed the appraisal of the house’s value to be accurate; otherwise they could end up repossessing a house worth less than the amount they were out on it – not a good situation

No one involved in writing and approving a mortgage these days cares whether the mortgage will eventually go into default because the mortgage will be sold to someone else. The people writing and approving the mortgage suffer no negative consequences whatsoever if the mortgage is eventually defaulted. Their incentive is to write as many mortgages and sell as many homes as possible.

So the appraiser is hired but the people hiring and paying her/him not only do not care whether the appraisal is accurate, they actually have an incentive that the appraisal be fudged upward so that the deal can work.

As a result there are a lot of people out there owning more on their houses than the houses are worth. In a lot of these cases the payments are more than the borrower can afford. The procedures and regulations that used to be in place to prevent these situations have been removed, ignored or subverted. And the media is not raising an alarm about this situation because the international corporations of which they are a part comprise the system that created it.

Small government conservatives like to complain that government is wasteful and inefficient, setting up layers of meaningless bureaucratic overhead, but this situation in which an appraisal is required but it is not required to be accurate was created by our free enterprise (capitalism) system. Health insurance companies that hire people to dispute and deny claims because that is more profitable then simply paying the claims are also part of our free enterprise system.

Do you get the impression that our society is headed towards a catastrophe but no one is paying attention?


Ellen Beth said...

Hi Dave. Good post.

I wanted to make you aware of a relatively recent case in which the investment house that put together the packages of loans for the secondary market was adjudicated liable for a predatory lending scheme. It's a Ninth Circuit case, but our fine Illinois Attorney General had her litigation team helping on this one. Here are some of the details.

Anonymous said...

I am a loan officer from a local non-profit organization and when we finance a property we refuse to tell the appraiser the amount of the purchase until after they have estimated a value of the property. That way we as the bank know how much it's really worth, and the family buying the property knows that they could sell the property for more than the loan amount. More and more ethical lenders are doing it.