Q: "I used your site approximately 30 days ago to try to refinance the loan on my four-family rental property; the rate was locked and the appraisal came back with a satisfactory value, according to the loan officer … I was told that loan processing would take a little time, but every time I checked I was told that everything was fine and proceeding on schedule. …

Today I received a phone call from the loan officer stating that the loan has been denied by the underwriter because the appraisal was not satisfactory. It seems that the comparables used in the appraisal were not "similar enough." I asked what that meant exactly and did not get a response."

A: It is a sorry state of affairs when a would-be borrower pays for an appraisal, which is not accepted by the lender who ordered it, and the loan is rejected as a result. While many transactions are torpedoed by appraisals that come in with values unacceptably low, in this case the value was satisfactory but the appraisal producing it was not. I am told by market insiders that before the financial crisis, this hardly ever happened, but today it is not unusual.

Appraisals are heavily based on comparables, which are similar houses in the same market area as the house being valued, and which were sold in the last six months or so. Much of the expertise of appraisers is in the selection of comparables, and in the ability to make informed judgments regarding how differences between the subject house and each comparable affect the value of the subject house.

A four-family house is much more of a challenge to an appraiser than a one-family house, both because the different units occupied by different families might differ significantly in their condition, and because comparables are more difficult to find. This has always been true, however, and does not explain why rejections based on unsatisfactory appraisals are more common today than in earlier years. This is not something that can be attributed to lender greed, since they don’t make any money on loans they don’t make.

The most plausible explanation is that the quality of appraisals has declined. To check that in the case at hand, I had the frustrated applicant send me a copy of the appraisal, which I went through step by step with an expert, who showed me the deficiencies. The "comparables" were anything but, and the valuation adjustments for differences between the alleged comparables and the subject property defied common sense. It was a poor appraisal, and its rejection by the underwriter was justified.

The quality of appraisals has declined since the regulatory ground rules were changed in 2009. In that year, Fannie Mae and Freddie Mac issued the Home Valuation Code of Conduct (HVCC), which declared that the agencies thenceforth would purchase only those mortgages that were supported by an "independent" appraisal.

The objective of HVCC was to insulate the appraisal process from influence by any of the parties with an interest in the outcome. Mortgage brokers and Realtors could no longer have any contact with appraisers, and lenders had to obtain appraisals in some manner that prevented them from exercising any control.

To protect themselves from liability, most lenders today order appraisals from appraisal management companies (AMCs), which intermediate between the lender and the appraiser. The AMC selects and pays the appraiser, receives and evaluates the appraisal, and passes it to the lender, who has no direct contact with the appraiser.

Because AMCs operate nationally but do not have appraisers everywhere, more appraisals are being done by appraisers who are not familiar with the local market. Appraisers working for AMCs are also paid less per appraisal than independents — some AMCs put appraisal assignments up for bid, with the low bidder winning the assignment. This may induce appraisers to invest less time. While most appraisals today are done with the same care and professionalism as before HVCC, the fringe of inferior appraisals is larger — and those are the ones that are rejected.

Before HVCC when lenders, Realtors and appraisers talked to each other, the transaction described above might have been aborted by informal discussions regarding the lack of adequate comparables. This would have saved the would-be borrower an appraisal fee. If the comparables were adequate but the appraisal was poorly done, the lender probably would have had it done again with another appraiser who the lender knew was up to the challenge.

HVCC was designed to prevent loan providers from pressuring appraisers to come up with values high enough to make transactions workable in a period of rapidly rising market prices. In the process, however, it eliminated the positive influence of loan providers on the quality of appraisals. In today’s market, there is no danger of inflated appraisals, but we are left with lower-quality appraisals.

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