Bank Regulators Seek to Revamp Home Appraisal Process

WASHINGTON — Federal regulators unveiled new proposals on Wednesday that would toughen appraisal standards as they continue to mull broader steps to improve disclosures and underwriting in the mortgage process.

One plan, issued by six banking regulators, would require an initial appraisal for "higher-risk" mortgages that would include an interior inspection of the home, as well as a follow-up appraisal in specific cases.

The Consumer Financial Protection Bureau, meanwhile, simultaneously issued a different proposal that would strengthen borrowers' ability to get free appraisal reports.

The proposed standards — mandated by the Dodd-Frank Act — have largely already been adopted by the industry, observers said, due to the fallout from the housing crisis. "Drive-by appraisals were common during the go-go days," said Bill Garber, the director of government and external relations at the Appraisal Institute. "The rules are based on the theory that mortgage lenders should have their eyes and ears wide open and enhance their collateral risk operations in higher-risk mortgage situations."

Under the first proposal, lenders would be required to provide borrowers of higher-risk mortgages with a free copy of their appraisal at least three days before the loan closes.

Such loans would be defined as those with interest rates at least 1.5 percentage points above the average prime rate. The threshold would 2.5 points higher in the case of jumbo loans, and 3.5 points higher for second liens. (The agencies asked for comment on alternative definitions for higher-risk loans.)

To prevent fraudulent price inflation, a second appraisal would be required if the home had previously sold less than 180 days earlier at a cheaper price. That additional appraisal would have to include analysis of why the two sales prices are different, conditions in the market and improvements made to the home between the two sales.

"This requirement would address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased," the six agencies said in a press release. (The proposal was issued by the CFPB, Federal Deposit Insurance Corp., Federal Housing Finance Agency, Federal Reserve Board, National Credit Union Administration and Office of the Comptroller of the Currency.)

But the final appraisal rule may also rely in part on the outcome of other Dodd-Frank-related rulemakings. The proposal on higher-risk appraisals would give a carve-out to any so-called "qualified mortgages" — a special class of loans deemed to have certain safe characteristics in compliance with new underwriting requirements. Yet the CFPB is still in the process of defining the "QM" standard.

(Loans secured by manufactured residences such as mobile homes, reverse mortgages and open-end lines of credit would also be exempted from the higher-risk appraisal rule.)

Edward Pinto, a fellow at the American Enterprise Institute, said he questions the utility of the joint appraisal rule for non-prime loans. Not only are the government-sponsored enterprises already requiring tougher appraisal requirements for the vast majority of new loans, he said, but the exemption of QM loans means the plan may have limited scope. As the market awaits the CFPB's regulation on underwriting, several lenders say loans not meeting the QM standard will be a rarity.

"What this is dealing with is a non-issue today because there won't be any higher risk mortgages as defined by Dodd-Frank," Pinto said. "They've already eliminated this particular piece of the market because they basically outlawed these types of loans under the definition of a qualified mortgage. The reason for that is the ramifications of originating a non-qualified mortgage are so egregious that no one is ever going to do it."

The appraisal rules also appear to tie in to a CFPB effort to merge overlapping disclosure requirements from different regimes into a simpler set of forms. Under its recent disclosure plan, the bureau has proposed an alternative calculation for annual percentage rates to include certain finance charges. That, in turn, could increase the amount of higher-risk loans subject to the appraisal rule.

The appraisal proposal asked for comments on that alternative definition, as well as others. Additional questions touch on the types of certification appraisers should have and the various exceptions from the rule, among other topics.

Griff Straw, chairman of the advisory board at Solidifi Inc., a Chicago appraisal management company, says most banks and lenders have already adopted many of the requirements.

"Most lenders already were using a full appraisal and desk review — or more — on loans with excessive credit risk layering," Straw said.

Lenders now also routinely check to prevent illegal "property flipping," in which an investor purchases a home and then resells it at a higher price in a short period of time, he added.

The second proposal, issued solely by the CFPB, clarifies for first lien loans when consumers can access appraisal reports and at what cost. Previously, borrowers could request copies of appraisal reports from lenders under the Equal Credit Opportunity Act. But a provision in Dodd-Frank, which would be implemented by the CFPB proposal, strengthened the rules to require lenders to notify loan applicants of their right to an appraisal, and provide copies of all written reports no later than three days before closing. While lenders could still charge a "reasonable fee" to borrowers for conducting the appraisal, the proposal would ban additional fees for providing the reports.

"When looking to buy a home or refinance a mortgage, consumers need the best available facts and data," CFPB Director Richard Cordray said in a press release from the bureau. "This rule would guarantee consumers receive important disclosures on how a lender determines the value of the home, making it easier for loan applicants to make informed decisions."