It appears the FHFA is making good on their promise. Fannie Mae announced on January 19, 2022 that they will be accepting desktop appraisals for eligible loan transactions. The team at Fannie Mae were the first to announce requirements lockstep with their Regulator that desktop appraisals will become a normal part of the appraisal product landscape. Let’s take some time to reintroduce Desktop Appraisals and explore the risks that are presented when a Desktop Appraisal is requested of an appraiser as part of the mortgage application process.
Prior to 2020, the most common appraisal label in the mortgage origination ecosystem was the Full Appraisal. The Full Appraisal was the prevailing appraisal product in use when lenders and other stakeholders obtained appraisals in association with mortgage applications. The Full Appraisal requires the appraiser to complete a viewing of the property being appraised, with no limitations on what was to be viewed (i.e. interior and exterior). The onset of the Covid-19 pandemic in 2020 introduced two new appraisal labels – the Exterior-only Appraisal and the Desktop Appraisal. Lenders and stakeholders allowed for some level of inspection relief with these two new appraisal products. Exterior-Only is self-explanatory, where the scope of work states the appraiser completed an exterior viewing of the physical components of the property and the appraiser relied on other sources to gather property and improvement details. Desktop refers to a scope of work where the appraiser did not perform any level of viewing of the property and relied on other sources to gather property details. All three labels refer to the scope of work completed by the appraiser when completing the assignment.
Appraisers have always had the ability to complete appraisals with limitations on their scope of work, provided it falls within the constraints of their standards of practice, or what is commonly known as the Uniform Standards of Professional Appraisal Practice (USPAP).
Up until recently, mortgage lenders and stakeholders, for the most part, did not have the ability to vary scope of work of appraisal assignments; Full Appraisals were the standard product.
Catalysts of change
We live in a world that is transitioning from the Information Age to the Digital Age. After years of accumulating, cultivating and refining data, there is a greater understanding of real estate data in its current form, and the risks associated with the integrity of data are more measurable and better understood than ever.
During 2020 and 2021 as the Covid-19 pandemic global pandemic disrupted our lives and the way we all do business, regulators, agencies, and the government sponsored enterprises allowed inspection relief in certain circumstances. The markets perceived no additional risk in transactions where the appraiser signing off on the valuation of the collateral being utilized for a credit decision did not physically inspect the property.
Part of the reason why there was no perceived measurable risk attributed to this change in process was because of adapted upfront lender controls that were established, creating guardrails on when inspection relief was appropriate. In turn, appraisers developed, supplemented, and maintained practices to ensure the data provided to the appraiser did not result in a misleading appraisal. Additionally, there was a healthy dose of government stimulus involved to ensure there would be no disruption in the capital markets.
The lender/appraiser ecosystem over time has adapted processes and technologies to achieve appraisal development and reporting that meets regulatory, agency, and investor requirements, as well as meeting the needs of individualized lender risk appetites. Lenders rely on regulation and policy. Appraisers rely on standards of practice and processes. There is a long history of technology advances adopted into the appraisal processes.
Inspection relief was successful as lenders and appraisers developed appropriate processes. What served all stakeholders was an environment of open and clear communication and the use of technologies that provided a level of confidence that risks would not exceed acceptable levels.
The announcement of moving into a reality where a lender’s use of a technology to support a Desktop Appraisal and would not be a hindrance to Fannie Mae acquiring a loan was not a surprise. What has caught some people off guard is the requirements that a Floor Plan be included as part of the Desktop appraisal. Today, for traditional appraisal products, floor plans are only required when the appraiser makes a determination of a functional issue with the floor plan. In practice, less detailed sketches are more common in appraisal reporting. That being said, the floor plan is a tool to factually represent how improvements and living spaces are configured, and is illustrative of the functional aspects of the improvements. It will give the reader of the report, and the person who will be providing the valuation, a visualization of what exists.
Desktop Process Challenges & Risks
The following questions come to mind: Is there a place where a borrower or their agent can get a copy of a floor plan for the collateral they are purchasing and posting as collateral for a loan? Can this floor plan be turned over to an appraiser and be used by the appraiser in the development of the appraisal required for the mortgage transaction? Can appraisers themselves offer floor plans as part of their appraisal service?
The announcement has been welcomed by some in the marketplace as building a process aligned with digital modernization of real estate appraisals, whether their goal is motivated by customer service, speed, or cost. The announcement has been met with less enthusiasm by others. The guidance is specific where needed, to fit the needs of Fannie Mae. It clearly gives respect to the standards to which appraisers must adhere to when producing services and to continue to earn a livelihood while assisting lenders and the GSEs with meeting their mission.
Like any appraisal product, there are risks associated with use. Risks to the appraisers producing the report and risks specific to the lenders who will be relying on the Desktop appraisal product to base credit decisions.
For the appraiser, the greatest risk lies in relying on information that may be erroneous and result in the appraiser providing a misleading appraisal.
The Fannie Mae guidance is clear that appraisers must have sufficient information to develop a credible report. When relying on information or data provided by other parties, including parties with a financial interest in the sale or financing transaction, the data is to be verified by a disinterested source. This is in lock-step with the appraiser’s requirement to complete appraisals consistent with USPAP. When an appraiser relies on work done by others, the appraiser is required to have a reasonable basis for believing the individual(s) are competent and to have no doubt that the work is credible.
There are no exceptions to this USPAP requirement, the appraiser is required to take the necessary steps to ensure that the information relied upon will not create a situation that misleads the intended user. Whether it is a floor plan or a sale price of a property, in practice, the appraiser develops processes and procedures to gain confidence that the obtained is accurate. The Covid-19 operating environment showed us we were all capable of developing and incorporating effective processes, and the recent requirement stating floor plans are required will provide opportunity for further refinement as we move forward.
Lenders will need to review and potentially adapt their appraisal ordering processes and appraisal quality control standards and procedures when underwriting the Desktop appraisal to ensure FNMA or any other intended user that the requirements are met. There is no relief to the lender when it comes to adhering to GSE-specific underwriting standards and processing procedures if the loan is to be sold to a GSE.
Fannie Mae’s announcement states the lender will be required to ensure:
1) the appraisal form ordered and received from the appraiser coincides with what was indicated in their automated underwriting platform message (Form 1004 Desktop);
2) the appraisal includes a floor plan;
3) and the appraisal meets all other requirements.
The control for each item above is through review and validation via the lender’s Quality Control process. Some lenders will have the ability to automate some of this process, but there will be a need for some manual process, as the ability to determine adequacy of the floor plan, or the ability to measure that all appraisal requirements are met, is not something that can be 100% automated through processes and technologies commonly used in the marketplace today.
The risks to the lender if those conditions are not met, can be presented either through denial of purchase or in the event of default, the requirement to repurchase the loan or make whole on any losses in the event the lender is found at fault.
There is one other lender risk I want to touch on, the risk that is posed when a decision by the lender is made to order a traditional appraisal after a desktop appraisal has been completed. Both Fannie Mae and Freddie Mac are clear in their selling guides that certain conditions must be met if a lender decides to obtain multiple appraisals. Quoting the Fannie Mae Selling Guide, “If the lender obtains more than one appraisal for a loan due to applicable law, regulation, lender policy, or otherwise, the lender must adhere to a policy of selecting the most reliable appraisal rather than the appraisal that states the highest value; document the reasons for relying on the appraisal, and submit the appraisal selected by the lender through the UCDP prior to delivery.”
There are going to be situations where the result of a desktop appraisal is going to conflict with the lender’s desired outcome, particularly early in the process when lenders and appraisers are figuring out effective and efficient processes. While this is not an uncommon occurrence of what happens today, there is one distinction- the Desktop appraisal product is optional. How a lender chooses to make that initial decision to obtain a Desktop appraisal, with or without input from the borrower, or pre-emptively sharing information with the borrower of potential consequences of relying on a desktop appraisal product (i.e. timing and cost), will have implications on the risks associated with any decisions further down the loan process line. Lenders will need to understand implications to any policies, procedures, or practices associated with reconsiderations of value or the decision to obtain another appraisal.
Operational and Reputational Risk Implications
The risks above speak not only to operational risk but reputational risk. Lenders, appraisers, and consumers will need to understand that there will be situations where the Desktop appraisal is off the table even when the automated underwriting system provides messaging that a desktop appraisal is permissible.
Lenders will need to manage borrower expectations and provide guidance to appraisers on what they consider acceptable practices, particularly in what is deemed reliable when data is provided by others, in particular persons with an interest in the outcome of a transaction.
Appraisers, in turn, will need to communicate with their lender clients what conditions will prevent an appraiser from moving forward with the scope of work limitations that are presented in completing a Desktop appraisal.
While the Desktop appraisal has the potential to provide a shift in how appraisals are completed going forward, it is going to be important that appraisers, lenders, and those parties involved in real estate transactions work together to ensure the integrity of the data is at the point where it needs to be to instill confidence and reliability to those parties relying on the processes. The marketplace has been calling for modernization and digitization of multiple processes in the mortgage origination workflow, including how appraisals are developed. The necessary steps to assemble and develop critical data on the property being appraised has not changed significantly in more than 20 years, with exception to incorporating digital imagery and relying on internet applications to source key data and information.
One of the world’s largest acquirers of mortgages has given notice that they will not stand in the way of incorporating the use of modern technology when it comes to collecting primary data on collateral. Technology and appraisal providers have been positioning themselves to accept and benefit from this process change. While it is clear there will be a need for mutual understanding of what will be required to attain a result that meets the needs of both the lender and the appraiser, it is also becoming clearer of the risk of potential outcomes when the choice is made to work in the environment of data collection technology advancement, or not.