For anyone who assumed that the toughened real estate appraisal rules imposed on the mortgage market last year would mean less monkey business in home valuations, here’s a shocker: Fraudulent appraisals actually soared in 2009, according to a lending industry study released April 26, and they now represent the fastest-growing form of home loan fraud.
The Mortgage Asset Research Institute found that while overall loan frauds rose last year by 7 percent, the incidence of frauds involving property valuations increased by 50 percent. MARI, a service of data company LexisNexis, collects information from 600 plus wholesale mortgage lenders who account for the vast bulk of all loans originated in the country. Once a year, it reports its findings on fraud trends to the Mortgage Bankers Association.
Though the biggest source of mortgage fraud in 2009 was intentional misinformation submitted by borrowers on their applications — bogus Social Security numbers, data on income, employment and assets — distorted valuations came in second. In previous annual reports, appraisal problems were far less prominent. As recently as 2006, just 16 percent of all mortgage fraud cases involved skewed property valuations. By 2008 it had jumped to 22 percent, and last year bad appraisals were involved in 33 percent of all mortgage frauds, according to MARI.
The sudden spike in appraisal shenanigans came despite the nationwide imposition of restrictions last year that were designed to limit interference in real estate valuations and to improve their accuracy. As of May 1 last year, mortgage giants Fannie Mae and Freddie Mac prohibited loan officers and brokers from selecting appraisers, and effectively encouraged lenders to use “appraisal management companies” that assign appraisers from their own networks nationwide.
The new rules, known as the Home Valuation Code of Conduct, stoked immediate controversy among mortgage brokers, appraisers, home builders and real estate brokers. Critics charged that because management companies pay rock-bottom compensation to appraisers — often as little as $175 for an assignment that previously earned them $350 to $450 — the new rules encouraged the use of inexperienced individuals, who frequently were not familiar with local market conditions.
Critics also charged that management companies forced appraisers to turn in their work within unrealistically short deadlines, even if they had to cut corners on quality and thoroughness.
Citing widespread evidence submitted by members about lowball and incompetent appraisals, the National Association of Realtors waged a lobbying campaign to persuade Congress to put the entire set of rules imposed by Fannie and Freddie on ice for 18 months. Congress has not acted on the matter to date.
Bill Garber, government affairs director for the Appraisal Institute, the largest trade group representing the industry, said the upsurge in bad appraisals last year “demonstrates what happens when lenders hire appraisers solely based on low prices and quick turnaround times.”
“This should send a loud signal to lenders to hire ethical and competent appraisers” if they want to avoid fraud in their loans, Garber said.
Freddie Mac spokesman Brad German offered a different view. Since the MARI study itself made no specific reference to the rule changes by Freddie and Fannie or to the use of appraisal management companies, “we see no connection between [the code] and appraisal fraud.” Fannie Mae did not respond to a request for comment on the study.
Jeff Schurman, executive director of the Title/Appraisal Vendor Management Association, which represents the appraisal management industry, had no immediate comment on the findings, pending a review of the data.
The fraud report covered every major type of valuation method lenders use to underwrite mortgages, including traditional appraisals, broker price opinions supplied by real estate agents, and electronic valuations, among others.
The biggest game fraudsters play: messing with or fabricating the information on “comparables” that form the basis of most appraisal reports. Rather than selecting nearby properties with broadly similar physical characteristics and recently recorded selling prices, bad appraisers typically came up with houses and characteristics that better fit their purposes.
Sometimes they just left out the negatives. Say, for example, the property they were valuing was located near a busy and noisy highway or railroad tracks that would normally depress its value significantly. No problem. Poof — the appraisal report could simply omit those issues.
What did fabrications like these achieve? Primarily custom-tailored property valuations that were often 15 percent to 30 percent or more off base, and allowed the sales contract and loan application to be approved. This, in turn, left lenders holding the bag when the mortgage went sour — raising losses and making the national foreclosure crisis even worse.
Ken Harney is a real estate columnist with the Washington Post.