Housing Appraisals: Watch Out for Bloat

Kevin Marois, a real-estate agent in Forest Lake, Minn., had to break the news to a client that his lakefront home, which he was planning to sell, was worth about $550,000--not $639,000, an amount based on an appraisal performed a couple of years earlier during a refinancing. An out-of-town appraiser hired by a California bank had estimated the home’s value using values in a pricier community 60 miles away. Eventually, the house sold for $555,000. “If I had priced it at $639,000, it never would have sold,” Marois says.

Homeowners may at first delight in a high appraisal, especially when they’re seeking a cash-out mortgage refinancing or a home-equity loan. After all, the bigger the number, the more they can get. But an overvaluation can lead them to overborrow, and later, when they resell, they could learn that the till they thought was full of money contains much less, or nothing at all.

PRESSURE TO PUMP

There are no data to say how serious or widespread appraisal inflation might be, but it’s definitely going around, says Don Kelly, vice president of public affairs for the Appraisal Institute, which represents 18,000 appraisers. In a 2004 survey by the Appraisal Foundation, a nonprofit standard-setting organization, 62 percent of the 6,500 appraiser respondents said they had lost work for failing to meet a prescribed value. If house prices drop, says Kelly, the overappraisal problem could be “a ticking time bomb.”

One of the more insidious factors pumping up appraisals is the pressure coming from mortgage brokers and bank loan officers. Their commissions are based on the size of the loan, which is pegged to the value of the house used as collateral, and they don’t receive payment until the closing. So they have a direct interest in seeing properties receive the highest possible valuation. If an appraiser brings in a lower value than the agreed-upon sales price, lenders may refuse to provide a mortgage big enough. The buyer then has to come up with more cash or renegotiate. If he can’t, the deal falls apart.

So common has the complaint of pressure become that in May bank regulators--including the Federal Reserve Bank, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency--warned the nation’s lenders against interfering in the independence of the appraisal process.