Breaking The Bank-Appraiser Cabal

I got a call the other day from the bank that holds the mortgage on my house. They wanted me to come in and talk with them about refinancing. They thought I could get a better rate. So on Saturday, I went in and spoke with a lady in the refi department. I could have gotten a real sweet rate – if I didn’t have my home equity line of credit. I got the HELOC near the peak of the housing bubble, so the combined value of my HELOC and my mortgage is well over what my house is worth today. That meant I had to go into a different loan program with a higher rate and I wouldn’t be saving very much.

But while I was talking to the woman, I found out an interesting fact. Now, back when I was rehabbing and renting properties, I did refis and loans all the time. I’ve probably been through the mortgage process as a borrower 15 times or more. I’ve got a fair idea of how the game is played. Or, I thought I did. I haven’t gone through the process since the housing bubble collapsed. Turns out a couple of things have changed. The biggest change is that the bank no longer can have any contact with the appraiser. The bank just orders an appraisal and the order goes to the appraisal company, who then doles it out to one of their employees. The appraiser contacts the borrow or home owner to schedule a time to look at the property. I think this is a positive step. I remember thinking how convenient it was that the appraisal would always come back right at or slightly above the sales price of the house. There seemed to be an obvious game going on where the bank would hint to the appraiser what figure they were hoping to get. And since the bank paid the appraiser, there was a strong incentive for the appraiser to meet that number. I’m sure this was a big factor in the housing bubble.

Of course, the new prohibition does not fully stop this practice. The appraiser still must talk to the borrower (assuming this is a refi and the borrower is living in the property), so the borrower can still tell his target value to the appraiser. I don’t think there will ever be a way around this. But I have heard from appraisers that they are also limited in the adjustments they can make. They have strict limitations on what improvements they can include. I had one appraiser tell a friend of mine that short sales and foreclosures now really hurt property values because appraisers are pretty much stuck using their sales price as comps and are very limited in the adjustments they can make. I would imagine one foreclosure or short sale in a neighborhood wouldn’t be too bad, but a neighborhood with several could see the property values really plummet.



In other news, it looks like the former owners and occupants in the hard money #15 property are being jerks. If you recall, he originally wanted $6,000 and one and a half months to move out. My partner offered $1,500 and four weeks. Now he is asking for $3,000. In the words of my partner, “fat chance.” The occupant has threatened to take the windows if he is not paid that much. Our lawyer advises to call the police if he does. (And yes, we do have insurance on the property.) Looks like this will be going to court to get the people out. And there are lots of people – 8 adults, 2 kids, and 3 dogs. Yeah, there will probably be a bit of remodeling that needs to be done when they leave. Such is a life of a foreclosure investor.

My others loans are doing well and paying on time.

Fear Mongering Comes To Mortgage Commercials

Mortgage companies must be hurting for business right now because I was shocked at a commercial I heard on the radio this morning. In an attempt to get people to refinance their mortgages, it used fear-mongering tactics that would have made the President proud.

The ad started off by saying that private mortgage insurance, or PMI, is required on all loans where the loan to value ratio is greater than 80%. That's true. However, the ad then went on to talk about the declining housing market and how homes may now have lost equity. Your loan, the ad warned, may now be above an 80% LTV! Don't be hit with an added PMI charge on your mortgage - refi now!

First of all, there is truth in the statement that the housing market has declined and equity may have been lost, thus pushing your LTV over 80%. But, and this is the deceptive part, I have NEVER heard of any lender that regularly appraises the houses their mortgages are based on to make sure they stay above 80% LTV! Never! If the loan is being paid on time, no one at the bank is going to ask for a new appraisal. The ONLY time a new appraisal will be obtained is if the house is sold or the loan refinanced. In short, PMI will not suddenly be added to a mortgage that does not already include it, despite what the ad implies.

When you stop to think about this ad, it doesn't even make sense. If a loan truly did rise above 80% LTV due to falling home values, and the current loan did not have PMI, then refinancing it would only serve to ADD PMI, no matter what, because a new appraisal would be obtained, thus verifying the higher LTV.

Phoenix Housing Prices

Things are slowing getting back to normal here. After being gone for a week and coming back and having to rebuild my computer after it crashed, I'm slowly starting to gain control over the items that piled up while I was away. One of the things I am catching up on today is my blog reading.

Last week, Kenric posted about the housing price drop in Phoenix. One thing he said was "If you have cashflow or breakeven you can survive this. That’s why cashflow is so important." That is oh so true. I have a co-worker who has been caught in the housing slump and next month will join the ranks of those who have been foreclosed on, a group that grew by 50,000 just last month alone. This co-worker is the epitome of the uniformed investor who jumps on a bandwagon and ultimately gets burned. A year or so ago, he bought an investment property in the Phoenix area and rented it out. His biggest mistake was in renting it out for less than his mortgage payment. He had negative cashflow from the start. Never mind factoring delayed costs like maintenance, vacancies, etc. There was no way he could get a positive cashflow. What's more, he know this and went into the deal willingly. His plan, like that of so many others in the real estate mania, was to hold for appreciation and then sell.

Through a combination of circumstance and ignorance, things went downhill quickly. The housing market tanked. He thought he couldn't sell the property while he had people renting it (even though I said otherwise), so he held on to it longer than he should have. As a result, he now owes more then the property is worth. One thing led to another and now next month he will lose the house and have a foreclosure on his credit report, not to mention an huge tax bill if the bank accepts a short sale before the foreclosure. Unfortunately, he still feels his only error was in not selling the property at the peak of the real estate bubble. The problem is, you can only tell a peak once you have receded from it. Sadly, he has learned no lesson from this.

Cashflow is king. Always make sure your rental income will cover your expenses!

Update: Literally about 4 minutes after I posted this entry, I found out my co-worker has sold the house. I don't have any more details than that, but I'm sure it was at a loss. His monthly payment was $2,600 and he had it rented for $1,800. Now, with all the foreclosures in the area. rents are around $1,100.

Analysis: Why Did Rental #1 Appraise Lower?

Since it's a lazy Friday afternoon, I decided to investigate why my appraisal of Rental #1 came back lower than one made less than 1 year ago. So I started looking over the two side by side and doing a point by point comparison. Here are the major highlights of what I found. NA refers to the new, lower appraisal I had done. OA refers to the original appraisal done in September, 2006.

Housing trends:
NA: sell time 3-6 months
OA: sell time less than 3 months

Driveway:
NA: No driveway
OA: driveway

Fireplace:
NA: 1 fireplace
OA: no fireplace

Patio:
NA: no patio
OA: patio / deck cover

Fence:
NA: cyclone fence
OA: no fence

Carpet:
NA: Carpet needs to be replaced in near future
OA: No repairs needed

Physical details:
NA: 7 rooms, 3 bedrooms, 2 baths, 1,585 square feet
OA: 8 rooms, 3 bedrooms, 2 baths, 1,640 square feet

Comps:
NA: 3 comps currently for sale from $74K to $79K
OA: 2 comps currently for sale from $77K to $88K

NA: 5 comps sold in prior 12 months from $47K to $79K
OA: 5 comps sold in prior 12 months from $75K to $90K

NA: Comps had inferior heat, air, superior car storage
OA: All comps truly comparable

Cost approach to value:
NA: Reproduction
OA: Replacement Cost New

NA: Site value $10K
OA: Site value $15K

The new appraisal rates the property at $62 per square foot. Since it also says the square footage is 55 square feet less than the original appraisal, this translates to a $3,410 drop in value. That alone accounts for one-third of the valuation difference!


So it's obvious appraisals are very subject to human error. I mean how hard is it to determine if a property has a fireplace or a driveway? Or to count the number of rooms in a house? And yet the two appraisers looking at this property differed on such seemingly cut and dried items as these. Now I will grant that comps sales have been lower, the market slower, and it is possible the tenants have destroyed the carpet in the 7+ months they've been there. However, I think the other errors can easily account for at least 50% of the difference between the two appraised values.

And yes, I did check to make sure they were actually appraising the same house :-) Pictures were included and all the other identifying details match. I am curious to see what the tax records state the square footage of the house is. I don't believe Oklahoma has that information available on-line, and I don't have the paperwork to look it up with me right now.