I am posting this article with the permission of my lenders - Debbie & Norm Lewis with Liberty Financial. Thought you might enjoy it.
It would seem that the Topic of the Week is appraisals. Issues tend to run in bunches, and I have been getting an earful about appraising recently. I think there are several factors at work here- first, very few folks, including Realtors, really understand what an appraisal is supposed to do. Add to that the fact that market conditions are exerting a lot of pressure on the appraisal process, and the result is a steaming stew of confusion, misunderstanding and miscommunication. I do not claim to be an expert on the appraisal process, but I think I have a pretty good grip on the basics. Let's talk about a few issues that might help you avoid, or at least understand, some problems.
First, what the heck is the purpose of the appraisal anyway? If you said "to determine the value of the property", you are already off track. The market value of the property has been (at least initially) determined by a meeting of the minds between a buyer and a seller. The appraiser's job is to support that value- or not. How many times has someone said to me, while rolling their eyes, "So, the appraisal came in right on the sales price? Gee, what a coincidence!" This is usually salted with a degree of sarcasm. Well, that's what is supposed to happen. The appraiser takes the information on the subject property, investigates other recent sales in the area, makes adjustments (plus and minus) for differences in the properties, and arrives at a value which presumably equals the sales price. This is supposed to assure the investor who is purchasing the loan that the appropriate amount of equity exists.
But wait, you say- the buyer and seller established the value- why do we need the appraisal? Well, there are several good reasons. First, it will come as no surprise that buyers, sellers and agents sometimes cook up schemes to sell houses under, ahem, "funny" circumstances. The appraisal should be the first line of defense in such cases. More often, however, the problem is ignorance or inexperience. A buyer from L.A. coming to Denver might think that two-bedroom bungalow for $350,000 is a great deal compared to what he is used to. He is not experienced in the Denver market. The same can apply when simply moving from neighborhood to neighborhood. The buyer may act impulsively or emotionally, but the appraiser is supposed to do his or her work strictly by the data.
Another common misconception, especially among Realtors, is that once the appraisal comes in on value, the process is finished. We may have been lulled into complacency by years of increasing values. Once the appraisal was in, for all intents and purposes, we were done. But wait! The appraisal still has to be underwritten, just like the credit package. 99% of the time this process goes unnoticed. However, if the underwriter does not like the comparables, the adjustments, or anything else about the appraisal, they can alter or reject it, or perhaps call for a field review or second appraisal to support the first one. Needless to say, many are caught by surprise when this happens, which it does more and more these days. And this also creates an interesting contractual conundrum- if the appraisal came in "on value" on the contract appraisal date, but was subsequently "shot down" by the underwriter, where does that leave us? A couple of knowledgeable Realtors with who I have discussed this issue are of the opinion that this circumstance would be covered by "loan conditions". I tend to agree, but I think it's a hazy area that is not well addressed in the contract.
Other issues to watch out for are personal property, sales concessions, large land parcels, and outbuildings. If the underwriter looks at the sales contract and finds what they consider to be excessive personal property, they will reduce the value accordingly. Usually the typical appliances, window coverings and the like will be ignored. However, if a $10,000 billiard table is included in the sale, you are likely to find $10,000 being subtracted from the appraised value. Large sales concessions will draw the same response. Basically, anything that is not "typical" for local transactions will be scrutinized closely. Under the umbrella of "typical" comes large land parcels. Residential mortgage investors do not like lending on unimproved property- that is to say, raw land. This is another issue that most of us do not encounter too often, so we tend not to pay any attention to it, but it is quite important. This is particularly true if you do any business in outlying areas. The "land-to-total-value" ratio is an item that an underwriter will address if the land parcel is larger than average. For example, if you sell a ten-acre ranchette in an area where ten-acre ranchettes are the norm, then you will probably be fine on your value. But if you sell a ten-acre ranchette in the middle of Lakewood, it is entirely possible that the underwriter will give value for a house on a half-acre lot, and exclude the rest from value. Needless to say, this can cause considerable distress to your transaction. The same applies to outbuildings- residential loans are not typically intended for the purchase of barns, workshops, airplane hangers, large storage facilities, etc. Again, if the building assemblage is typical for the area, then there is a pretty good chance that it will not draw any attention. But this is an issue that you might want to consider if you find yourself writing a contract on this type of property.
In theory, all of this should be relatively easy to sort out. However, this is a "people" business, and many decisions that are made are subjective. Do your homework and your prep work, and your chances of avoiding problems are considerably improved. And remember, this ain't your daddy's real estate market. It would be hard to overstate the amount of scrutiny that everyone on the mortgage side is subjected to these days. Appraisers, loan officers, underwriters- we are all considered crooks until we prove otherwise. If I haven't shared them with you before, I think you will appreciate Norm's Three Rules of Mortgage Lending. I was given these rules years ago, when I was but a pup in the business, and a lot of it wasn't making sense to me. One stressed-out afternoon I was sitting at my desk, contemplating the inordinate cruelty of the real estate business, when a loan file suddenly spontaneously combusted (as often happens to piles of slimy refuse that overheat), and out popped a slab of Formica engraved with the following:
1) Thou Art Guilty Until Proven Innocent
2) One Size Fits All
3) Thou Shalt Not Confuse This With Common Sense
Since then I have been very comfortable with it all. Pay particular attention to Rule Three, and you'll have a good basic understanding of the mortgage business.
Norm and Debbie Lewis Liberty Financial Group 303-263-8019 or 303-910-1629
Thanks NORM!!!!
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