Your Lender’s Appraisal is Likely 4% Too High

A study looked at a particular set of 8,533 houses that Fannie Mae foreclosed on from 2012 to 2015 and where two appraisals were done on each house. The first appraisals were done right after Fannie took ownership and the second appraisals were done after the houses later went under contract to buyers. The second appraisals were the typical lender’s/bank appraisals that are ordered by the mortgage companies of buyers in the process of buying a house.

The first and second appraisals were done within six months of each other and no alterations or repairs were made to the houses between the two appraisals. The biggest difference wasn’t the house. The biggest difference with the second appraisals was the appraisers knew what the agreed-upon sales prices were in the sales contracts.

Did knowing the agreed-upon sales prices in the written sales contracts affect how the appraisers appraised the values of the houses? Yes, it did. A lot.

Looking at the exact same 8,533 homes.

  • When appraisers didn’t have any contract prices when they did their appraisals, only 45% of the appraisals came in at or above the (future) contract prices.
  • But later when appraisers knew the contract prices, 93% of those appraisals came in at or above the contract prices.

On average, the second appraisals were 4% higher than the first appraisals.

This is known as “appraisal bias” or “confirmation bias” – appraisers don’t like their appraised values to come in under the price agreed upon by the buyer and seller in the purchase contract because their clients, mortgage companies, don’t like it. It’s a lot more work for everyone when the appraised value comes in less than the price in the purchase contract.

One of my conclusions from the study is that your lender’s appraisal will protect you from paying WAY too much for your house but it won’t protect you at all from paying a few percentage points too much for your house.

Appraisal Creep

Let’s say an appraisal comes in 4% too high as would seem common from the study. That 4%-too-high, appraisal-approved house sale price might then become a comp (comparable property) for the next appraiser to use when appraising the value of another house nearby. Then that house might become a comp for a third house, and so on. If each of these sale prices is a little too high due to appraisal bias, house prices would naturally tend to slowly ratchet up even if the market fundamentals are flat. 

This “appraisal creep” would – all on its own –  tend to cause house prices to rise. The faster the sales, the more the appraisal creep. The more house sales per month, the more house prices increase per month due to appraisal creep.

A 2013 study found the average appraisal bias for residential refinance transactions was above 5%.

Solutions

The VA manages their appraisals differently which reduces appraisal creep and they have a lower foreclosure rate than the FHA even though VA has a lot of zero down payment mortgages. The VA selects the appraiser, not the mortgage company. See #49.

In Scotland, before a seller puts a home on the market, the seller has to have a home inspection and appraisal done and has to make this “Home Report” available to all potential buyers. It’s a huge consumer protection measure. 

To the degree that appraisal creep exists, this Scottish consumer protection strategy would also tend to slow down price increases, which would reduce the size of real estate booms and busts, which would stabilize and increase household wealth, and stabilize and increase national economic growth.

76 Secrets of U.S. Home Ownership – Table of Contents