It's the appraisals
For all the bad press that sub-prime and stated income (aka Alt A) loans with exotic features like "80/20 combos", "negative amortization", and "payment option" are getting the real culprit in the current housing crises is, in my opinion, inflated appraisals:
Appraising the value of a house has never been an exact science. But the $4-billion-a-year appraisal industry provides a crucial reality check for the system. Banks need an appraisal to make a loan. Regulators and mortgage investors require it to insure against fraud. Consumers rely on appraisals to give them some measure of confidence they aren't paying too much.
In refinancings, the appraisal is the only thing that tells a consumer what a house is worth and how much he can borrow. So perhaps it's not surprising that appraisers have come under pressure from some of the people selling mortgages.
MONEY has obtained more than 100 e-mails and faxes sent by loan officers to appraisers across the country. The language varies from asking if a predetermined value was possible to promising more business if a number could be hit.
"Many homeowners are finding out that the equity they were led to believe they had in their house is not actually there," says John Taylor, president of the National Community Reinvestment Coalition.
The article goes on to document issues with mortgage brokers manipulating the system to get high appraisals. But pressure from brokers and fraud aren't the only factors here. There is a fundamental problem with appraisals that do not take into account short term variance and long term trends, as well as underlying macro-economic factors such as household incomes, and worst, use sales as "comps" for re-fis. As I mentioned in my last post the only definitive way to determine the value of a house is to sell it. But sale prices are subject to large short term fluctuations due to supply and demand--yet every sale is fed back into the appraisals for nearby houses when they are refinanced. This means that in a neighborhood with low turnover a single sale of a hot property, say for 10% above asking price, can actually create a significant bump in the whole neighborhood's "value". Just a handful of aberrantly high sales in one area over a short period can thus create literally millions of dollars of (phantom) equity in nearby homes, which the owners are then tempted (or even encouraged) to "tap into".
But what seems to be consistently overlooked is that a refinance and a sale are not equivalent activities, and valuing a home in a refinance as if it were for sale would probably reduce values substantially. Take our imaginary neighborhood--assume there 100 homes, 9 interested buyers, but just 6 homes for sale. Each home for sale gets multiple offers and all sells for 10% above asking prices, and 3 buyers are left wanting. After witnessing this bump lets assume 4 people in the neighborhood refinance. In fact if all 4 of those homes actually were up for sale there'd be just 3 interested buyers left to take them, and the situation would be reversed, with homeowners bidding down to get the buyers, and 1 home left stranded on the market. This problem isn't that significant when the number of home sales is much larger than the number of refinances, but right now the ratio stands at roughly 60%/40% purchases to refinances and refinances have been even higher over the past few of years. Add this to the strong effect speculators (people buying homes for the potential appreciation rather than to live in them) have on short term prices, and you get a combustive mix. As a result I think many appraised values are a mathematical fiction, even free from fraud they don't reflect a real world value.
In refinancings, the appraisal is the only thing that tells a consumer what a house is worth and how much he can borrow. So perhaps it's not surprising that appraisers have come under pressure from some of the people selling mortgages.
MONEY has obtained more than 100 e-mails and faxes sent by loan officers to appraisers across the country. The language varies from asking if a predetermined value was possible to promising more business if a number could be hit.
"Many homeowners are finding out that the equity they were led to believe they had in their house is not actually there," says John Taylor, president of the National Community Reinvestment Coalition.
The article goes on to document issues with mortgage brokers manipulating the system to get high appraisals. But pressure from brokers and fraud aren't the only factors here. There is a fundamental problem with appraisals that do not take into account short term variance and long term trends, as well as underlying macro-economic factors such as household incomes, and worst, use sales as "comps" for re-fis. As I mentioned in my last post the only definitive way to determine the value of a house is to sell it. But sale prices are subject to large short term fluctuations due to supply and demand--yet every sale is fed back into the appraisals for nearby houses when they are refinanced. This means that in a neighborhood with low turnover a single sale of a hot property, say for 10% above asking price, can actually create a significant bump in the whole neighborhood's "value". Just a handful of aberrantly high sales in one area over a short period can thus create literally millions of dollars of (phantom) equity in nearby homes, which the owners are then tempted (or even encouraged) to "tap into".
But what seems to be consistently overlooked is that a refinance and a sale are not equivalent activities, and valuing a home in a refinance as if it were for sale would probably reduce values substantially. Take our imaginary neighborhood--assume there 100 homes, 9 interested buyers, but just 6 homes for sale. Each home for sale gets multiple offers and all sells for 10% above asking prices, and 3 buyers are left wanting. After witnessing this bump lets assume 4 people in the neighborhood refinance. In fact if all 4 of those homes actually were up for sale there'd be just 3 interested buyers left to take them, and the situation would be reversed, with homeowners bidding down to get the buyers, and 1 home left stranded on the market. This problem isn't that significant when the number of home sales is much larger than the number of refinances, but right now the ratio stands at roughly 60%/40% purchases to refinances and refinances have been even higher over the past few of years. Add this to the strong effect speculators (people buying homes for the potential appreciation rather than to live in them) have on short term prices, and you get a combustive mix. As a result I think many appraised values are a mathematical fiction, even free from fraud they don't reflect a real world value.