San Diego Housing Market News and Analysis
Fraud and the Home Appraisal Business
Submitted by Rich Toscano on December 30, 2005 - 11:16am
The Voice of San Diego is at it again, this time with an article about appraisal fraud.
In the past, appraisers would estimate the fair market value of a house based on comparable sales, construction costs, and various other methods. If the appraised value came in too low, the mortgage would not be approved because the bank would want to ensure that the collateral on the loan (i.e. the house itself) was worth a certain amount in comparison to the loan amount.
Now, though, many appraisers claim that there is enormous pressure from some mortgage brokers to appraise homes based not on their actual value, but on the figure necessary to close the loan. The mortgage brokers, after all, are not the ones lending the money, so their main incentive is to close the deal. And since they are often the ones who hire the appraisers, it's possible to see how there would be a conflict of interest.
For now it appears that we are still at the "he said/she said" stage, with some players claiming that fraud is rampant, and others saying that while there are a few bad apples, everything is for the most part legitimate. The truth, as usual, probably lies somewhere in between.
What can we learn here from the lessons of history? According to financial analyst and historian Marc Faber:
Well, that sounds sort of familiar. And if Dr. Faber's pattern holds true, "fraud on a massive scale" may be going on under our noses, only to come to light after the bubble has begun to deflate and the market has turned ugly.
It makes intuitive sense: on the way up, it would be human nature to turn a blind eye to questionable behavior, because everyone is getting rich and there is seemingly no harm done. But there is harm done, because the fraudulent behavior has helped to push valuations above where they'd be otherwise, and set the market up for a serious correction. The harm comes later, in other words. Or, to quote another financial market luminary (Warren Buffett):
As to the existence of appraisal fraud, only time will tell for sure. But if history rhymes yet again, I'll bet we find that a surprising amount of fraudulent behavior has been taking place throughout the housing business.
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