Dennis' Mortgage Blog

Note: Mortgage Disclosure Improvement Act now in effect, make sure procedures followed to avoid unnecessary delays in closings!

Question of the week:  There is a lot of controversy over appraisals right now, what goes into an appraisal?

Answer:  The Home Value Code of Conduct has certainly disrupted our industry.  While a lot of people unfamiliar the situation think it is a good idea, those individuals subject to the measure since it went into effect in May have seen some really, really bad appraisals that have cost homeowners and buyers a lot of money in lost equity, fees and restructured transactions.

How can appraisal be bad?  Well there are many factors to an appraisal and depending on how they are placed in a report a value is supported or unsubstantiated.  I will quickly go through the major elements of an appraisal to give you an idea of the many different factors. 

One major factor that must be understood is that appraising a property is part scientific, part mathematics, part experience and part subjective.  From all the factors, and more, listed below it is up to the appraiser to select which comprise the best match for the subject property and arrive at a value.  Note that three ordinary appraisers can appraise the same property and arrive at three different values, three excellent appraisers with knowledge of a local area may arrive at three different values but the differences would be very slight.

The main part of an appraisal is obviously the subject property.  The appraiser inspects the property, measuring the gross living area and creates a sketch of any structures.  He notes the location, any adverse elements that may impact value such as flight paths, busy roads or abutting commercial developments. 

Next the appraiser researches other properties within the same neighborhood that are most like the subject property that have closed escrow recently.  While standard appraisal practice allows for using comparables that have sold as far back as six months, emphasis is always placed on those sales that have closed most recently and closest physically to the subject property.  In analyzing the closed sales the appraiser makes adjustments for size of property, bedroom and bathroom counts, amenities such as fireplaces, pools, patios, lot size, location, and condition if known (aside: this has been one of the biggest issues with many recent appraisals through HVCC as appraisers are misstating condition of either the subject property or comparables). 

Along with researching closed comparable properties the appraiser also lists and compares any properties that have entered escrow but have not yet closed escrow, called “pending sales”, and also active listings on the market that would be the alternative properties a buyer would have looked at prior to making an offer to purchase the subject property.  These properties, pending sales and active listings, are adjusted in the same manner as the closed sales with three differences.  First the listed, or asking, price is used instead of a closed sales price.  Second, the number of days on the market is noted on the appraisal.  Third the average percentage of closed sales price to listed price for closed sales is calculated and used to adjust the values for the pending and active listed properties.  Why not just use the price the property sold for on pending sales?  Good question, agents do not give out the final price on pending sales until they close escrow so as not to compromise the seller should the property fall out of escrow.

After the comparable closed sales, pending sales and active listings are obtained and analyzed the appraiser selects three to five closed sales, up to two pending sales if available and up to two active listings if they are available.  He then makes his final adjustments based on market analysis.  The appraiser must research the last twelve months of market history for the neighborhood and note the amount of inventory on the market for periods through the past year, the average percentage of closed price to listing price, the number of days homes were on the market, if the predominance of sales were distress (foreclosure or short-sales) or “traditional” (one family selling to another with no bank approvals needed for seller).  If asking prices and closed prices are increasing, flat or declining for 12 months, 6 months and 3 months.  From this data the appraiser states whether the property is in a stable market, increasing value market or declining value market and by how much.  Once this is determined all the comparable sales are then given “time value adjustments.”

The time value adjustment is critical in our Southern California market as the number used can be somewhat subjective and has a great impact on the appraised value.  What the actual figure is for the neighborhood’s declining value and how it is applied to comparables is one of the key factors that separates quality appraisers from inexperienced and sloppy appraisers.  Is the factor being applied evenly, is the factor used from the neighborhood or a much broader region, is the factor adjusted for recent sales activity?

The purpose of an appraisal is not to determine the exact value of the property, but rather to inform the bank if the asset, the property, supports the liability, the mortgage, that is being applied for by the borrower.  In choosing comparables appraisers can find the best possible comparables supporting a sales price that has been agreed upon by the buyer and seller, or he can choose comparables that show the lowest possible value of the home.  In some neighborhoods we see comparables from top to bottom that vary by over 30%, which end of the comparables an appraiser chooses has a huge impact on the market and future sales.

This is pretty quick, though a little lengthy, explanation of the basic factors in an appraisal, I hope it provides some understanding for you as to the multitude of factors considered in determining appraised value.

I will keep this link on my “Question of the Week” section to assist new homeowners:

IRS Form 5405 for First Time Buyer Tax Credit for those eligible for the up to $8000 credit. Note credit only for those who close escrow before November 30, 2009 under current legislation.

Have a question for me?  Ask me!   

Our bond charts this week looked like a green staircase.  Those who follow CNBC or other markets shows know that green means up.  Today is mortgage backed securities are surging even higher and from Monday’s open are up over 120 basis points as I write this.  Pop quiz: is it good or bad when bond prices go up?    Answer:  good if you want lower rates, higher prices mean lower rates.

The increase in prices and drop in yields, or rates, is a bit of a head scratcher as the Treasury dropped over $250 billion in notes on the market which should have depressed prices.  Initial jobless claims dropped a bit lower yet again.  Housing prices appear to be stabilizing.  Second quarter GDP dropped only 1%.  All this news would typically depress bond prices and have investors running for stocks.  Well that did not happen, they did run to stocks this week, but money also flowed into bonds and specifically mortgage backed securities

Helping the mortgage rates has been the continuing purchase of Fannie Mae and Freddie Mac securities by the Fed.  The Fed purchase program has kept rates low, artificially so in my humble opinion, which has helped the housing recovery.  What we need to watch out for is the market reaction when the Fed stops the program and natural market supply and demand influence the market.

Back to the GDP figure real quick.  The slowing of the decline of the Gross Domestic Product is good news for the economy.  You have to shrink slower before you can grow and that is what the numbers show.  While one quarter an economic analysis should not make, it does add some credence to my predictions early in 2009 that I have reasserted from time to time that the current cycle should bottom out sometime in the Fall of 2009—remember the last day of Fall is December 19^th so I have the rest of the year! 

Which leads me to my long term cautionary tale once again.  Most of the money coming out of Washington, most notably the stimulus funds, will not hit the economy until next year.  When we should be heading out of the recession and in a flat or growing, albeit slowly, economy.  When we will be very susceptible to inflation.  Which is not good for interest rates. 

Rates had a big week dropping the most in one week for conforming since mid-January.  Caution as the market may be over-bought leading to sell offs next week and rates rising.  My advice is to look to lock today or early Monday morning if market starts in the red:

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional  4.875%                           Down 0.375%

30 year conforming-jumbo 5.375%                   Down 0.25%

30 year FHA    5.00%                                      Down 0.375%

30 year FHA jumbo 5.625%                            Down 0.25%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, and period rate is locked (i.e 45 days instead of 30 days).

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

I have been informed by two very interested parties that “summer is almost over and school will be starting too soon.”  By my calendar math summer is now half over, or you still have half of summer left!  Make the most of it!

I’m around all weekend to help you, your clients, your friends and family with any mortgage needs and products.  You can always apply on-line at my website.

Have a great weekend,

Dennis

Remember this update is posted weekly on My Blog at www.DennisCSmith.com ; feel free to forward the link to family and friends who may be interested in past commentaries.

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