Will technology replace appraisers?Charlie W. Elliott Jr., MAI, SRAAVMs, appraiser's role, government guarantees, For at least 10 years or so, there has been a buzz going on in lending and appraisal circles. It might be occurring in the office cafeteria, trade publications, professional association meetings or at conferences. It has to do with a question that can cause quite a stir depending upon which camp you are in and how you put shoes on the feet of your children and bread on the table. It all started, as best as I can remember, back in the 1990s. This was just about the time when automated valuation models (AVMs) were first being used on a significant scale. This new tool was greeted with enthusiasm by lenders and not so enthusiastically by appraisers. You don't need an MBA from Harvard to understand why these two camps--lenders and appraisers--might be at odds. Lenders are quick to tell anyone who will listen that the appraisal is the most difficult part of the mortgage-lending puzzle. Why would two groups of professionals be at such odds on an issue that involves what many would consider a common sense approach to protecting the interest of the average citizen and taxpayer? Herein lies the problem. For all practical purposes, the government guarantees (in one of two ways) all loans made in our country. The first guarantee is through the government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, which purchase mortgages from lenders. This system allows financial institutions to replenish their supply of mortgage capital so they can make additional loans once their capital is exhausted. The GSEs are not allowed to buy loans that do not meet their collateral guidelines, which, in most cases, require the opinion of a certified appraiser. The second guarantee is through the Federal Deposit Insurance Corporation (FDIC), which guarantees depositors that their money is safe when deposited in banks and other financial institutions. These deposits cannot be considered safe if banks make portfolio loans that are not sound. In our country, there are very few mortgage loans that the GSEs, the FDIC or both do not cover. We need not go back further than the savings-and-loan debacle of the 1980s to understand why federal regulators require that government-backed mortgage loans are properly underwritten and secured. Federal law changed after the multi-billion-dollar bailout through the Federal Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). Among other things, this law requires that federally backed loans, depending upon the degree of risk, are secured by properties that have been appraised by state-certified real estate appraisers. After this law was passed, all professional real estate appraisers were required to become state certified, thus providing the mortgage industry with the environment in which we work today. Given that the government is on the hook for most mortgages, for all practical purposes, many lenders are not using their own money. It is in their best interest to make as many loans as they can, as economically and expeditiously as possible. Appraisers can become an obstacle in the path of the lending process. Appraisers can delay the closing of the transaction by a week or more while the appraisal is being prepared or from an opinion of value, which prevents the loan from being made. For these reasons, most lenders would prefer to not have an appraisal prepared. Appraisers, on the other hand, typically see non-appraisal evaluations as inferior to true appraisals and as a threat to their livelihood. This concept may be better understood by loan originators if they considered the possibility that their job could be eliminated due to new legislation requiring all banks to take loan applications over the Internet, thereby eliminating the loan originator. Federal guidelines have loosened up in recent years, permitting loans to be made, in some cases, without a certified appraisal. In many of these cases, the alternative is an AVM, a collateral evaluation tool born strictly out of technology. Depending upon whom you talk to, it appears that about 15-20 percent of all first mortgages are made using an AVM as an exclusive property evaluation tool. Said another way, some 80-85 percent of all loans now require a certified appraisal supporting the value of the collateral prior to closing. On equity lines, which banks usually keep in their own portfolio, lenders report that AVMs are used on an estimated 50 percent of the loans as an exclusive method of collateral evaluation. The remaining 50 percent require some sort of appraisal. The question is whether the industry will permit more, or all, collateral evaluations in the future to be made via AVMs, thereby eliminating the need for an appraiser. While undoubtedly, there will be many collateral evaluations performed electronically in the future, there are a number of reasons why the appraiser's role is critical to the collateral evaluation process. There are two reasons that guarantee that the services of many appraisers will be needed in the future. The first is that while AVMs can provide accuracy in many instances, they are generally not as accurate as a certified appraisal. This is especially the case in less-populated areas that have a less than homogenous stock of housing. Certified appraisers inspect houses and make judgmental decisions in a way not possible by electronic evaluations. Issues such as making allowances for design and appeal, property condition, property location as well as proving that the property actually exists can be challenging to the most accurate AVM. Only people can do these things and there will always be a need for this service. Second, in today's market there is more concern about fraud and the solvency of the GSEs. While this is not to say that appraisers cannot and do not participate in fraud, fraud is less likely when an independent appraiser is hired to locate the property, evaluate it and make a report of their findings. The key here is independence, where an unbiased party to the transaction engages the appraiser. There is also quite a stir today on Capitol Hill about the financial strength of the GSEs. Any legislation designed to address GSE financial strength will undoubtedly favor the use of more, not fewer, appraisals. There will always be low-risk situations where appraisals are not required. To prove this, loans are made to individuals that require no collateral at all and are based solely on the borrower's perceived ability to repay the loan. In such cases, if a house is thrown in as additional security for good measure, having an appraisal may be less necessary. Contrarily, a loan made to someone with questionable credit in an area where housing values are unstable or where there are few comparable sales will most surely require a certified appraisal. It has been my observation that in some geographic areas, AVMs either cannot be performed at all or have an accuracy deviation that can amount to 50 percent or more of the value of the property. So, the lender and the appraiser should get used to one another. For the foreseeable future, the appraiser's job is safe and the lender can expect to use them. Oh, and one last closing thought. In many if not most cases, AVMs provide values less than that of an appraisal due to the age of the comparables and the shortcomings of the AVM to reflect adjustments. Lenders may just be able to make more and larger loans with the help of the appraiser when AVM values are lagging behind the market. Charlie W. Elliott Jr., MAI, SRA is president of ELLIOTT & Company Appraisers, a national real estate appraisal company. He can be reached by phone at (800) 854-5889, by e-mail at [email protected] or through the company's Web site at www.appraisalanywhere.com.
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