Tighter Underwriting and the Appraisal
By Charlie Elliott Jr., MAI, SRA

There is no official barometer or forecast that we know of, capable of providing direction as to the attitude of financial institutions toward underwriting policy flexibility. Given the absence of such readily available information, one may wonder from where it may be obtained.

Due to the sometimes-sensitive nature of such information, it may not be readily available. Furthermore, much of the need for tighter underwriting stems from mistakes and/or other issues which most financial institutions are averse to displaying publicly. Therefore, getting the straight scoop on such issues is not always easy and sometimes must come from those outside of the loop. Being a veteran of a number of boom-and-bust lending cycles and being somewhat out of the loop, I would say that it is time to place your bets on a tightening of the purse strings from most lenders. There are a number of smoking guns listed below that provide us with this evidence.

Many banks have been extremely busy lately. With the demand for mortgage loans being at an all time high, much of their managerial talent has been devoted to keeping the product flowing through the pipeline, and there has been little energy left over to focus on underwriting changes. Now that things have slowed down, there is more time, and with all of those loans salted away, there is perhaps more reason to reflect upon the quality of the loans, especially the collateral.

Five major regulatory agencies, including the Office of Comptroller of the Currency and the Board of Governors of the Federal Reserve System, recently sent a joint directive to regulated financial institutions concerning appraiser independence and how appraisers must be selected for mortgage transactions. The directive forbids borrowers or loan originators with a direct interest in the property or transaction from selecting appraisers. It further stated that individuals independent of the loan production area must oversee the selection of appraisers.

The Bush Administration has proposed the creation of a new Government Sponsored Enterprises regulator for Fannie Mae and Freddie Mac. This is due to the large size which they have grown, and to questions about their accounting practices, not the least of which is the $1.2 billion accounting error recently disclosed by Fannie Mae.

Loan fraud has been a major topic of conversation at many lender conferences this year. Most government agencies associated with mortgage loans as well as the major banks are focusing on this issue. The practice of flipping seems to be one of the more popular schemes designed to bilk financial institutions.

Home foreclosures, are reported by Reuters to be at a record high during the first quarter of 2003. Their statistics are not only in numbers of homes lost to foreclosures, but by the percentage of homes foreclosed upon as a percentage of all home loans. Reuters reported that homes loans in the process of foreclosure in the first quarter of 2003 was 1.2% of all outstanding loans compared to a 1.18% for the fourth quarter of 2002.

Personal bankruptcies were up again in 2003 to a record high. The Mortgage Bankers Association reports that the increase is 7.8% over that of 2002.

Interest rates are on their way up. The Mortgage Bankers Association forecasts that interest rates on a 30-year-fixed-rate mortgage will rise from 5.5% in the second quarter of 2003 to 6.7% in the first quarter in 2005. Many would-be borrowers will be finding themselves marginally qualified for a loan, which they would have easily qualified for a few months earlier.

With all of the smoke coming from these guns, one would have to be on another planet not to sense a change in the air involving the underwriting policies of financial institutions. These indicators provide us with substantial evidence that the sentiment of the mortgage underwriter is going to be less positive than, say, only a few months ago. This will involve the appraisal, and here is how.

Real estate appraisals contain dozens of components, which affect the collateral value of a property. While it is the job of the appraiser to report the facts objectively, many of these components are not in black and white, but in shades of gray. Underwriters often place emphasis on these components, which can make or break the deal. One example, which can be a deal breaker, is whether the property is adjudged to be located within a suburban as opposed to that of a rural area. First, it is a matter of opinion as to whether the property is suburban or rural. There are no hard and fast rules as to what constitutes a rural or suburban setting.

Not even the Fannie Mae Guidelines are specific on this one. There is a humorous theory, which holds that rural, is where you can see cows from the front porch. This may be all right, but what if the cows are on the back 40 acres on the day of inspection, taking a dip in the farm pond? The appraiser sees no cows so the property is suburban, right?

There are other methods used which also come into question, such as how far the property is from the nearest places of shopping or employment. What constitutes shopping, the country store up the road or the new mall 30 miles away? Employment may be in the back yard or in the nearest city.

There are many other criteria within the appraisal that can affect the suitability of the property that may seem just as nebulous. Examples, such as the distance to the comparable sales, the remaining economic life of the improvements, the size of the comparable sales and the percentage of the adjustments of the comparable sales, all can fall prey to the underwriter’s policies. When underwriting gets tight and loan approval on a particular property becomes questionable, these issues seem to raise their ugly heads. In some cases, underwriters will reject a loan strictly based upon one of the above conditions lying outside of their requirements, regardless of the appraised value.

In summary, there would seem to be little question that underwriting will be tighter in the months to come. Whether you make your living selling loans, underwriting loans or appraising property, the upcoming environment will generate the necessity for a more heads up attitude toward those subtle nuances within the appraisal. We will all find ourselves having to look twice at those finer points. This sometimes generates heated discussion, which may include questions of competency, ethics and or intent. Since we all, as professionals, have our area of turf to carve out, display and protect, it behooves us to approach our craft with an understanding of those issues within an appraisal, which may be of a concern to underwriters.

Charlie W. Elliott Jr., MAI, SRA, is President of ELLIOTT® & Company Appraisers, a national real estate appraisal company. He can be reached at (800) 854-5889 or charlie@elliottco.com or through the company’s Web site at www.appraisalsanywhere.com.