Appraisal Inflation

By Kenneth R. Harney

Saturday, April 21, 2007

Have inflated appraisals helped fuel the surge in foreclosures on credit-strapped borrowers? Are such appraisals at the core of many mortgage-fraud schemes?

The four largest trade groups representing appraisers say yes -- and they are asking federal financial regulators to crack down on lenders and loan officers who put pressure on appraisers to raise valuations to allow overpriced deals to go through.

Led by the 22,000-member Appraisal Institute, the groups told regulators April 11 that subprime lenders experiencing high rates of foreclosures often have been guilty of "systematic inattention" to the accuracy and the sources of the valuations backing the mortgages they funded.

Such lenders:

Accepted loans that had zero or minimal down payments without taking hard looks at the qualifications and track records of the appraisers supplying the numbers. Yet in softening housing markets, accuracy on property valuations is essential whenever down payments are tiny and borrowers' credit histories are shaky. A zero-down mortgage made to unqualified buyers on a house worth thousands less than the appraisal in a depreciating market is a financial cluster bomb waiting to explode.

Failed to require "firewalls" separating loan officers working on commission from the appraisers hired to value the properties to be financed. National studies repeatedly have shown that commissioned loan officers often demand that appraisers cooperate to hit whatever number is needed to push the transaction to closing -- or lose future business. Ninety percent of the appraisers in a 2006 national survey by October Research said they had experienced threats, nonpayment of fees and other forms of coercion. Many said they had lost business by refusing to play the game.

Lender complacency about appraisals also has enabled con artists to bilk banks and investors of billions of dollars in home-mortgage-fraud schemes. The four appraiser groups cited FBI estimates that mortgage-fraud losses are now approaching $3 billion a year -- and many of those schemes start with intentionally inflated property valuations that lenders fail to spot.

A senior member of the Appraisal Institute provided an inside look at one type of scam that is turning up across the country. It's called "cash out at closing," and it uses overstated property valuations as the starting point.

Gary Crabtree, president of Affiliated Appraisers in Bakersfield, Calif., documented the practice recently for the FBI and state financial and real estate regulators. The basic scenario, Crabtree said, involves real estate agents who have listed houses that aren't selling. To move the properties, they entice buyers or friends to "submit an offer [for the home] that is $30,000 to $100,000 above the current list price" with the promise that they will get substantial cash at closing.

The real estate agents then amend the multiple-listing-service asking price to match the artificially inflated offer price. A house that had been sitting for months with no takers at $450,000, for example, might be relisted by the agent at $525,000.

Then, working with a cooperative appraiser who has promised to hit the number and an unscrupulous mortgage broker who simply wants the commission, they "change the [loan] documentation to reflect the [artificially inflated] sales price." The loans typically are for 100 percent of the price of the house. The seller nets the price he or she had originally listed -- $450,000 in this example -- and the buyer gets some or all of the $75,000 inflated differential as cash at closing.

The wholesale lender purchasing the loan from the broker doesn't look hard at the appraisal and funds the excessive loan amount none the wiser. Public records do not reflect the $75,000 slush in the transaction. The real estate agents and loan brokers pocket their commissions; the buyer pockets the cash from the closing proceeds and makes loan payments for a while and then stops. Within months, the property is headed to foreclosure.

"It's total fraud, of course," said Crabtree, who is documenting 32 cases of alleged appraisal hanky-panky for state regulators and the FBI. "You can throw a dart at just about any large subprime lender, and something like this [scheme] is going to stick."

Yet some lenders are in denial that they have accepted grossly inflated appraisals. Crabtree said he contacted one major East Coast lender with the documented details of a cash-back-at-closing scam that he submitted to state regulators. So far, the lender has not even returned phone calls, according to Crabtree.

To compound the problem beyond the individual foreclosures, the inflated selling prices of the homes remain in the system for use as comparable sales prices for valuations in the coming months.

That $525,000 recorded closing price on the house that wasn't selling at $450,000, in other words, might now be available on the public records as a comparable house for overvaluing upcoming sales.

Kenneth R. Harney's e-mail address is KenHarney@earthlink.net.