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Should the fox be guarding the henhouse?

National Mortgage Professional
Aug 22, 2008

What sub-prime underwriters look for in appraisalsKen Ormanalt-A lending, appraisals, underwriters, fair market value Welcome to "The sub-prime forum," a column designed to help improve your knowledge of alt-A lending and offer tips to increase your share of this lucrative market. Ken Orman is president and co-founder of Plano, Texas-based Kellner Mortgage Investments. As a mortgage professional, Mr. Orman has more than 14 years of experience working in the mortgage lending industry. For obvious reasons, sub-prime lenders require a licensed real estate appraiser to assess fair market value. Sub-prime lenders have trusted residential real estate appraisers for decades to describe, measure, illustrate and document the details about the property the borrower is pledging as collateral. That's a lot of responsibility for one person to have, and amazingly, the vast majority of appraisals are accurate and reasonable. As in most cases, the only view a lender has of a subject property is through the eyes of the appraiser. Wholesale and correspondent lenders are two or three steps removed from the original order. Assuming that the loan officer ordered the appraisal from a trusted and knowledgeable real estate appraiser, an accurate and detailed appraisal can make all the difference in an underwriter's approval. This article will attempt to detail some crucial elements of an appraisal and rank their importance during the approval process. After speaking with several underwriters at three of the largest securitizers of sub-prime mortgages in the nation, I found these common themes. The following assumes the appraisal is not fraudulent, the property is not flipped and the appraiser is not on the lender's ineligible list. •Fair market value and appraisal date •Photographs •Comparable sales (comps) •Marketability •Zoning •Automated Valuation Models (AVMs) Fair market value and appraisal date It is rare that an underwriter will review an appraisal's fair market value and say, "I think that the subject property is worth more than that." Shockingly, one underwriting department claims that appraisals have inflated values of 110 percent. This rule may seem alarming to those who have faith in the appraiser's opinion. Certainly, not all appraised values are inflated, but it is difficult for underwriters who have seen so many pushed appraisals over the years not to be skeptical of the values provided by appraisers. Additionally, the date of the appraisal is also of interest. All of the underwriters I spoke with said that they are likely to highly scrutinize not just the appraisal, but also the entire submission, if the appraisal is more than 60 days old. They assume that the file has been shopped to several lenders already and there must be something wrong with it. Photographs Pictures are worth a thousand words. Pictures help illustrate the condition of the property, curb appeal, visible likeness to the comps and the view of the subject's immediate surroundings. Many appraisers do a great job of using addendums to describe additional features of the subject property but neglect to photograph them. Underwriters prefer picture book appraisals as opposed to novels. In fact, in some cases, the very first items of an entire loan submission that an underwriter will review are the photos of the appraisal. Comps Of course, the subject's comps are vitally important to the final report. Comps are the means by which the appraiser justifies his findings of fair market value, marketability and price per foot. Most properties that are located in urban and suburban neighborhoods are rife with comps. In these neighborhoods, properties sell frequently and sales prices are updated regularly. However, there are instances of extreme stability. In these cases, appraisers must broaden their search for comps and look outside of the subject's neighborhood to find properties that sold within the most recent six months. Most underwriting guidelines require appraisals to use comps that are located within the subject's neighborhood boundaries described by the appraiser. Underwriters will condition the appraiser to address the reasons he had to use comps outside those limits. All the underwriters said that they would like to see appraisals that use comps that have the same square footage, room count, view and lot size as the subject, have a basement, pool or outbuildings to match the subject and be within the subject's neighborhood boundaries or one mile, whichever is less. However, as often is the case, these types of properties may not be available to use as comps, and the appraiser must search for properties that best resemble the subject outside the neighborhood. For example, a subject property located in a rural area of Texas was compared to properties that were within the limits of a 4,000-person town. All of the comps were clustered four to five miles east and were 10-15 years newer than the subject. Even though the square footages and room counts were similar to that of the subject, the underwriter requested additional comps because the comps were far superior to the subject. There were several reasons the comps were not considered comparable to the subject, but the most obvious was location. The subject's appeal was rural, and the comps were considered suburban. Moreover, the appraiser had to make several adjustments to the comps to arrive at the subject's fair market value. As a resolution, the appraiser provided two additional comps that had rural influence by broadening his search to 10 miles and using sales that were 13 and 16 months old. Marketability Underwriters want to know that the subject is marketable within three to six months. Lenders need to know that their collateral will sell quickly in the event of a foreclosure. In many cases, the collateral is the major reason for approving a sub-prime loan. Most institutional lenders do not consider themselves equity lenders, but for many borrowers who have fallen upon excessively hard times, having ample equity is their only way to appeal to lenders who might otherwise decline their applications. In such an instance, the borrower is helped by an appraisal that accurately depicts the subject property's neighborhood as healthy, where properties are frequently sold within three to six months of listing. Zoning Appraisers must take a few extra steps when assessing subject properties that are not zoned for residential development. Some cities (Houston, for example) do not employ zoning requirements. In these instances, the comps will also not have zoning limits. For properties that are zoned agriculturally, appraisers must provide comps that have the same or comparable zoning. Many lenders require evidence that the subject property is not being used as an income-producing farm, sits on several acres and is zoned for agricultural use. Subjects that are zoned as mixed-use or commercial properties must have the following: •A rebuild letter from the city stating that the subject can be rebuilt as a residential dwelling; •Similar comps (if the subject is mixed-use, all of the comps must be mixed-use in an enterprise that is similar to that of the subject); •Confirmation that the subjects highest and best use is that of a residential or mixed-use dwelling. AVMs AVMs are becoming more sophisticated and accurate. Counties across the United States are updating sale and transfer data much quicker and more readily. AVM fees have come down substantially in the last couple of years. I am now recommending that my customers find an AVM that is accurate in their area and use it as a way to help their lenders substantiate the subject property's value. For years, conforming lenders have been using AVMs as a way to completely waive the appraisal. Since there is still a lot of subjectivity to sub-prime lending, the appraisal is critical to the underwriter's lending decision. This brief article does not scratch the surface of all of the different details to consider while reviewing appraisals. There are particulars, such as multiple listing service listings, sale prices, maps, land-to-value ratios and built-up percentages, to analyze. In conclusion, the future is clear. Appraisals, like everything else in this business, will at some point be automated. Until then, the appraiser is the most important third-party vendor to sub-prime underwriters, and the appraisal remains a critical analytical tool for lenders. Fully understanding appraisals will be a great benefit to loan officers who want to better serve their customers and lenders. Ken Orman is president of Kellner Mortgage Investments, a nationwide wholesale sub-prime lender based in Plano, Texas. He can be reached at (866) 416-9995, ext. 105 or e-mail ken.orman@kellnermortgage.com.
Published
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