In August 2012, six federal financial regulatory agencies issued a proposed rule to implement Section 1471 of the Dodd-Frank Act which sets forth appraisal requirements for “higher-risk” mortgage loans.
The intended purpose of the proposed rule is to tighten valuation standards for homes in order to reduce the risk of appraisal fraud, a move meant to reassure creditors, borrowers, and investors alike. Section 1471 was created as part of Congress’ intention to prevent the use of false or inflated appraisals in obtaining mortgages. If the proposed rule is finalized without amendment, lenders seeking to issue high-risk mortgage loans will be “unable to value properties on the basis of broker-price opinions, automated valuations, or drive-by appraisals”. The proposed rule would affect mortgages with annual percentage rates (APRs) at designated levels above the Average Prime Offering Rate (APOR). First-lien loans (such as standard mortgages) with an APR 1.5 percentage points above the APOR would be classified as a higher risk mortgage under the proposed rule, while first-lien jumbo loans with APRs 2.5 percentage points above, and subordinate-lien loans with an APR 3.5 percentage points above the APOR would similarly be considered higher-risk.
The proposed rule requires financial institutions to obtain a written appraisal performed by a licensed or certified appraiser prior to making a higher-risk mortgage. The appraiser would be required to conduct an interior inspection of the property, providing for a new safeguard against shoddy and misleading appraisal practices. Creditors would further be compelled to give a free copy of any completed appraisal to the borrower at least three business days before closing to allow the borrower to pull out or have a separate appraisal conducted at his or her own expense.
Although it will likely impact the ability of creditors to lend to borrowers with poor credit, the rule is aimed squarely at preventing illegal house “flipping” that is orchestrated with the help of false or inflated appraisals, a growing problem throughout the past decade. Fraudulent resellers are able to benefit from appraisals that over-value the property in question, which allow them to turn a quick profit after making minimal upgrades to the property. To prevent this practice, the proposed rule requires two independent appraisals in situations where the seller acquired the home within 180 days of the resale (and potentially in all situations where the consumer is paying a higher price than that for which the seller originally purchased the home, although the agencies have requested input on implementing a price threshold).
Forcing all potential borrowers to foot the cost of the certified appraisal that the proposed rule implements would lead to millions in aggregate costs nationwide, but the overwhelming benefits of the proposal have muted any negative reactions so far. As noted in the proposed rule’s summary, if each borrower would be required to pay $600, on average, for an appraisal, it could add up to over $27 million in additional costs nationwide. Nevertheless, the billions in mortgage fraud that have accrued over the past decade overshadow this paltry amount and suggest the proposed rule may be worthy of support from all sectors of the mortgage industry.