A plan to jump-start housing
The price at which a willing buyer and a willing seller agree to transact is a better measure of the true value of the property than an appraisal based on prior prices of similar properties. Because many transactions are not getting done because of faulty appraisals, it makes sense to eliminate the appraisal requirement on purchase transactions.
The traditional underwriting rule, that loan amounts be based on the lower of sale price and appraised value, had little force before the crisis because appraisals rarely fell below the price agreed upon by the buyer and seller. It matters a great deal now because the quality of appraisals has declined markedly, and all too many come in below the price. When that happens, the likelihood is high that the transaction will be aborted.
I have written about the decline in appraisal quality before. The number of transactions has declined markedly, forcing appraisers to check the sale prices of properties that are much different than the subject property.
The physical structure and amenities may be very different, they may be located further away where the market may be different, and the transactions may be foreclosure sales or short sales at concessionary prices.
Furthermore, because of the structural changes in the appraisal market resulting from the Home Valuation Code of Conduct, appraisers are now being paid less per appraisal and invest less time per appraisal than was the case before the financial crisis.
Appraisals are unavoidable on refinance transactions where there is no market test of property value. On purchase transactions, they are a costly and unnecessary nuisance that can sabotage transactions.
Eliminating appraisals does not mean elimination of property inspections, which may still be required to assure lenders that the property has no major physical flaws.
Next week we'll discuss more needed changes.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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