What are Requirements for Appraiser Independence?
Appraiser independence requirements are a set of regulations imposed on lenders and mortgage brokers designed to ensure that parties do not exercise undue influence over the appraisal process. One example of this is that lenders typically cannot receive compensation for ordering an appraisal, and appraisal companies cannot hire appraisers by providing payments such as bonuses, gifts, etc. These regulations typically apply to transactions where a property is being bought with a mortgage loan, or when a borrower is refinancing a property that already has a mortgage. Appraisals performed by the lender in connection with second mortgages and home equity lines of credit (HELOCs) , as well as appraisals requested by homeowners for most other purposes are not subject to these regulations. The rationale for the independence requirements is to prevent undue influence by parties that have a vested interest in the outcome of the appraisal process. For example, if a bank could unilaterally choose the appraiser, it could select one who will give more favorable estimates. Without safeguards, this could lead to appraisers colluding with banks to inflate values for a hidden fee. Thus, regulations imposing safeguards on the appraisal process are necessary to maintain the integrity of the appraisal system. Among these safeguards are the independence requirements.
The Evolution and Background
In the 1970s, the rules for real estate appraisals were rudimentary at best. Often, lenders soon after the closing of a loan would attempt to influence or control the appraiser’s judgment. Some unscrupulous parties would attempt to reduce the appraised value of a piece of collateral in order to make it easier to foreclose. Others would attempt to increase that amount to reduce the borrower’s down payment. In either case the result was an independent appraisal process that was often and frequently harmed by outside influences.
The concept of appraiser independence requirements stems from the influence that these outside actors had on real estate appraisals over the years. Beginning with the Truth in Lending Act ("TILA") in 1969 and the Real Estate Settlement Procedures Act ("RESPA") in 1974 Congress sought to shore up the real estate industry from those who would manipulate the appraisal process for their own financial gain.
The 1989 Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") was passed in response to the savings and loan crisis and required S&L institutions to acquire appraisals from certified or licensed appraisers when making any federally related transaction. The Act also established the Appraisal Qualification Board ("AQB"), which outlines minimum qualifications in the areas of exam content and passing criteria for state licensing and certification.
The Dodd-Frank Wall Street Reform and Protection Act ("Dodd-Frank"), passed in 2010, built upon those earlier appraisal independence requirements and added new regulations designed to further protect homeowners and ensure that appraisers would be not be subject to manipulation. These include restrictions on who, and how those seeking to influence the appraiser could exert leverage on appraisers. The ability to influence appraisal decisions was eliminated whereby many state and federal agencies require that fees be established following a bona fide and independent, competitive process.
Primary Regulations and Compliance Requirements
The landscape of appraiser independence requirements is largely shaped by federal regulations, including the Home Valuation Code of Conduct (HVCC) and most recently the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). Implemented in 2009, the HVCC significantly overhauls mortgage lender policies for ordering appraisals. It most notably prohibits lenders from directly selecting appraisers and requires lenders to use an appraisal management company (AMC) for all transactions in federal related mortgage transactions.
Prior to implementation of the HVCC lenders and appraisers often provided gifts, meals and promotional items to one another, a practice that is now scrutinized under the Appraiser Independence Requirements (AIR). The AIR specifically require that compensation paid by the lender to the AMC must not benefit the AMC based on the closure of a single appraisal order. In addition, the AIR also allow for the requesting of an appraisal from an appraiser with whom the AMC, or any affiliate, has had a professional relationship in the past. Violation of the AIR can result in a rescinded loan and potential liability for any fees charged, or damages. The AIR require strict compliance by lenders, AMCs and appraisers with regards to compensation and ordering of appraisal services. The compliance standards vary for each type of entity, and are specifically tailored based on the level of interaction each will have with appraisers.
The Dodd-Frank was signed into law in 2010 in the aftermath of the financial crisis, and also implemented specific rules regarding appraiser independence. Dodd-Frank grants the Bureau of Consumer Financial Protection the authority to prohibit the use of coercion, extortion or any other threats against appraisers. It also allows for increased penalties for non-compliance of the AIR. Additionally, the Dodd-Frank requires that lenders: not mislead appraisers; provide clear underwriter instructions; ensure that appraisers receive competent orders; establish policies and procedures to ensure that employees do not engage in prohibited communications with appraisers; take appropriate action when they become aware of prohibited communications; and ensure that all employees are trained on the importance of complying with the AIR.
Issues In Maintaining Independence of Appraiser
Despite the requirements aimed at ensuring that appraisers are free from undue pressure and coercion, challenges still remain for both appraisers and lenders in maintaining truly independent valuations. For instance, some lenders have been known to pressure borrowers into using "preferred" or "recommended" appraisers despite the fact that the borrower has the option to pick their own appraiser. While this practice isn’t illegal per se, many borrowers may feel pressured to use a "recommended" appraiser out of fear that they will be denied their loan if they don’t. The line here between "recommended" and "required" becomes blurred, and creates a much greater chance for inexperienced or unwary borrowers to be taken advantage of. Another issue is the potential for conflicts of interest. For example, some fraudsters have attempted to do this by engaging the services of colluding appraisers who agree to falsely overstate property values in order to help the fraudulent transaction succeed . In cases like these, the fraudster benefits by either getting the desired loan amount without the borrower having to pay a higher interest rate, or by selling the property for an inflated price to a willing purchaser. Since the pressure and incentives are on both sides, it isn’t uncommon in some markets to have numerous complaints being filed for unethical behavior in the appraisal process. In light of the possibility for abuse, the consequences can be severe for both appraisers and lenders if proper precautions are not taken. For appraisers, failure to comply with the independence requirements could subject them to disciplinary actions, loss of their license, civil liability, or criminal prosecution. For lenders, possible repercussions could range from civil actions, fines, or in some cases even criminal prosecutions.
Best Practices in Maintaining Requirements for Appraiser Independence
The following best practices are designed to ensure compliance with appraiser independence requirements:
- Lenders are required to provide advance disclosures to creditors of the availability of an independent appraisal. Lenders should also exercise caution in selecting appraisal management companies for their particular needs.
- With the unbundling of services, lenders should be assessing what aspects of the valuation process are being performed in-house and whether that work will be subject to appraisal independence restrictions.
- Underwriters must be committed to the independence of the appraiser. This may mean training credit analysts, underwriters, loan originators and loan processors on how to effectively communicate with appraisers and the appropriate parameters for such communication.
- Before contacting an appraiser, underwriters should ensure that their concerns are related to the appraisal and not issues as to the transactions themselves.
- Appraisers must be given the opportunity to respond to concerns. This is especially important for non-cash-out refinances where the appraiser should be allowed to review any K-1s, W-2s or IRS forms, as necessary, to determine the proper pricing and valuation of the property. It is also important for shareholders because refusal to close the loan due to a qualified appraiser’s assessment of the property violates the rules.
- Mortgage brokers and real estate professionals should be familiar with the requirements of the FIRREA as well as OCC, FDIC and OTS regulations to avoid inadvertently violating appraisal independence.
Future of Requirements for Appraiser Independence
As we look to the future, the evolution of technology will continue to have a major impact on the appraisal process. Big data will influence the industry, and pressure for a more efficient appraisal process will increase in the years to come. As a result, the industry is likely to see a greater push towards broadening the array of information sources available to appraisers, which will in turn broaden the scope of their assignments. Home values will be increasingly based on complex analytics and software programs. In the end, the evolution of technology will force all parties involved in the valuation process to change their label on appraisal independence – it’s not so much about avoiding improper influences or relationships, but rather providing a fair analysis of the home that is unbiased by those parties involved . An appraiser’s evaluation should be based on reasons that are readily understood, regardless of his relationship to the developer, builder, lender or homeowner.
In the years to come, we may begin to see rules adopted throughout the industry that provide clearer, more concise definitions of independence. We can also expect to see heightened focus on the necessity to disclose appraisal relationships to all parties involved in the valuation process – this would be a significant step in providing the transparency that is needed to achieve appraisal independence. While our world continues to evolve and the development of technology speeds on, one fact is certain: Independence is about the appraisal itself. The future of appraisal independence can be defined by one word – transparency.
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