Appraisers can burst your bubble
by inflating the value of your home
By Michael D. Larson • Bankrate.com

How much is your home worth? Better find out before heading to the lender's office or you might end up with a mortgage you can't afford.

The problem stems from the way the industry calculates property values. Loan originators, many paid on commission, sometimes pressure appraisers to fudge their numbers to make mortgages work, experts say. That means people who don't have a ballpark figure in mind before they borrow -- or who don't verify numbers that sound too good to be true -- could be setting themselves up for financial ruin.

"It's an acknowledged problem," says Cameron Rogers, senior vice president of Chicago Title-Market Intelligence Inc. The Hopkinton, Mass., division of Fidelity National Financial Inc. does appraisal work for lenders who outsource that step of the loan process.

"We've had some clients that are very strongly pushing on value. They may have loan processors that if the value's not there, they pick up the phone and say, 'Well, I need $5,000 more,'" he adds. "From a sales standpoint of course, you want to satisfy the applicant's desire because you're more likely going to get that person's business. But are you really doing that applicant a service by pushing it? Maybe not."

Homeowners just want the job done
Many homeowners don't think about how loans get done, just whether they're approved. But one of the most important steps, from both a consumer and lender perspective, is the property appraisal. If a property isn't worth enough to support a loan, that loan won't be made. If the value comes in high enough for a loan but not as high as a borrower expects, the borrower's financing costs will be higher. That's because the appraisal determines the mortgage's loan-to-value ratio and the higher that ratio, the more onerous the loan's terms.

Today, companies use several methods to determine a property's worth. They can access the local tax authority's data, for instance, or run computerized models that calculate a value based on recent sales and property trends in the area. Humans will sometimes be called in to verify that information via a "desktop evaluation." Or, a full-blown appraisal involving an indoor and outside inspection of the property by a licensed appraiser will be required. Lenders generally use the more thorough methods with purchase transactions, though they also require them on riskier home equity loans.

"It really varies from institution to institution, but it's based on the risk-acceptance criteria that the credit committee happens to accept," Rogers says. "Typically, the decision is based on loan amounts and credit criteria. The less risk and exposure perceived, the quicker, simpler methods are then applied."

Manipulating the numbers
In a perfect world, the appraisal is just like the title search, which is just like the recording of the deed at the courthouse -- another step in the closing process the borrower doesn't need to worry about. But the appraisal can be manipulated in ways that hurt unsuspecting consumers, and that's why homeowners need to tread carefully.

Say a borrower owes $70,000 on a first mortgage and wants to take out a second one for $30,000 to consolidate debt. If the lender won't lend at more than 95 percent loan-to-value and the property appraisal comes back at $100,000, the borrower is out of luck. The same holds true for the loan officer, who gets paid a commission based on the number of loans closed in a given time period.

But if the home value can be coaxed up to $105,300, the problem goes away. Originators know this, so some will try to talk appraisers into modifying their estimates. Experts say that isn't too tough because those estimates rely to some degree on an appraiser's subjective evaluation of property and market conditions.

Originators often the origin of price inflation
"It starts with the originator trying to make the deal happen," says Sandy Nickol, a regional president with Republic Bancorp Inc.'s  mortgage company in Farmington Hills, Mich. "Sometimes you can't close the deal unless you can get the customer a mortgage of 'X.' If they're trying to pull cash out to pay off three credit cards and it doesn't make sense to refinance today unless they can do that, the whole deal is going to hinge on an appraisal that's high enough to do that."

At first glance, the process might look harmless. After all, it helps borrowers get the loans they want. But in reality, overinflated appraisals trap consumers with too much debt and lock them out of the refinance market. They can also force people into default.

Say our sample borrower lost a job and needed to sell the property to move somewhere cheaper. Buyers aren't likely to pay much more than the property's actual $100,000 worth, even if some random appraisal pegs the value at $105,000. That means the borrower wouldn't get enough money from the transaction to settle the two debts, considering the cost of the real estate agent commission and pre-closing repairs.

"It really becomes an issue where for whatever reason it's necessary to sell the property," Rogers says. "You're left with a shortfall, a large shortfall."

Protecting against appraisal fraud
Fortunately, there are several ways savvy consumers can avoid the appraisal problem. They can research and track down reputable lenders, for example, because those companies usually have checks and balances in place to make sure their appraisers aren't bending the rules, as do the outsourcing companies they use.

"We have an agreement with a national vendor who does most of our appraisals for us," says Carolyn Hart, senior vice president of credit risk management for FleetBoston Financial Corp.'s mortgage company. "They handle that function. They screen them. They do the reference checks. They do the licensing checks and, also, their performance is checked through them."

Borrowers should also get a rough idea of their property's worth before shopping for loans. They can contact local real estate agents or visit one of several registration-required Web sites, including Domania.com and HomeGain.com, for such estimates.

Owners may want to go back through old tax receipts to see how much their properties were assessed for and how recently those assessments were performed, too. The extra-cautious can even order their own full-blown appraisals, but those cost anywhere from $300 or $350 on up to $600 in some remote locations.

"It's really a research project on the part of the consumer," says Greg Dennis, president of LandSafe Appraisal Services. The Plano, Texas-based company does property evaluations, title searches and other work for lenders.

Mortgage customers can protect themselves once they've started the application process, too. Under federal law, a borrower is entitled to a copy of the lender's appraisal before closing, says Republic's Nickol. A quick review of the document will show whether the property described matches the actual home.

As for people who've already closed on inflated-appraisal loans, legal experts recommend they contact a local real estate attorney. They may be able to sue their original appraisers for negligence or violations of their state's consumer practices acts. Borrowers should also file complaints with the agencies or boards responsible for overseeing appraisals in their states.

Still, the best thing to do is avoid trouble in the first place. Borrowers can accomplish that by either understanding the mortgages they're signing and the home values they're based upon, or hiring people who do.

"The person should really have some familiarity with what values are in the neighborhood and what likely they would be able to sell the house for," says Denis Murphy, director of Civil Justice Inc., a Baltimore-based legal assistance group. If not, "get a lawyer before you sign the documents."