It amazes me how flawed the structure of the wholesale lending process is. Someday during an economic downturn or future lending crises, this will come out with the wash. Until then, its status quo.
How it began…
As banks floundered in the early 1990’s during the recession, the non-revenue departments were cut back, which included…you guessed it…appraisal departments. The order and review function, which requires administrative overhead, was shifted to mortgage brokers who would bear the staffing risk. Mortgage brokers are generally paid a commission of 1 point, or 1% of the mortgage. The appraisal fee, which generally starts at $300 to $500, is either paid in the borrower’s application fee or the absorbed by the mortgage broker.
In relatively short order, the wall between the sales function and underwriting essentially went away and so did the buffer between bank loan reps driven by a commission incentives and the appraiser, who is supposed to be assessing the collateral for the lending institution.
Large appraisal factories sprang up across the country hiring trainees who would simply fill out appraisal forms and make the deals. Without inhouse appraisal departments to review these reports, they were essentially accepted at face value. Many experienced firms either shut down or moved into other areas of valuation.
Why does this matter?
Lets count the ways.
- The borrower is under the assumption that the licensed or certified appraiser is independently assessing the value.
- Lending institutions have no idea what their collateral is really worth and the implicit risk to their portfolio.
- These lending institutions are government insured.
- Guess who pays the bill in the next banking crises?