The 3 "Cs" of Lending Capacity to Pay does the borrower make enough money to repay loan? lenders use qualifying ratios Creditworthiness [Character] is the borrower likely to repay loan on time? lenders uses credit reports Collateral [qualifying the property] does the property meet the lender s property standards? if the borrower does not repay the loans, would a foreclosure sale of the property repay the loan? lenders rely on appraisals Property Standards Lenders establish minimum property standards for properties that they will accept as collateral for loans Property standards include: Minimum property condition For example, must have forced air heating system Types of properties For example, only 1-4 unit residential properties Standards cannot unlawfully discriminate Fannie Mae/Freddie Mac Property Standards Fannie Mae and Freddie Mac have minimum property standards for loans they purchase Example: no physical deficiencies or conditions that would affect its livability Environmental hazards on the property or in the vicinity of the property Lenders who plan to sell loans to Fannie Mae or Freddie Mac must be certain that the properties meet Fannie Mae/Freddie Mac minimum standards Other lenders may choose to use Fannie Mae/Freddie Mac guidelines for their loans Fannie Mae Condominium Standards Fannie Mae must approve the condominium complex for the loans it purchases that are secured by condominium units Fannie Mae charges a loan level price adjustment of up to.75% for loans secured by condominiums FHA and VA Property Standards FHA and VA have minimum property standards for loans that they insure or guarantee Examples of FHA minimum standards: Unacceptable property types: Boarding houses, bed and breakfasts, other commercial Unacceptable site conditions: Environmental hazards, unstable soils, adjacent to gas storage tanks, no vehicle access to public or private street Unacceptable improvement conditions: Defective construction, termites, poor workmanship, inadequate attic ventilation, defective roof, broken windows Combined utility meters FHA Repair Conditions The appraisal may note that property repairs are a condition to FHA insuring the loan Repairs may be classified as Cosmetic Examples: worn carpets, holes in window screens, or small cracks in a windowpane Cosmetic conditions affect value but repairs are not required Required Examples: leaky or worn-out roof, termites, structural damage or defects, improper site drainage
VA Minimum Property Standards Examples of basic requirements No defective roofs Natural ventilation of attic spaces Adequate electricity for lighting and equipment Examples of site requirements Access to public street Access to unit without passing through another unit Appraisals An appraisal is an opinion of value by an appraiser Appraiser is someone who is competent to perform valuation services Other names for appraisals: VA: Certificate of Reasonable Value (CRV) Now known as a Notice of Value (NOV) FHA: Conditional Commitment/Statement of Appraised Value Purpose of the Appraisal Appraiser must determine the purpose of the appraisal, including type of value Appraiser s assignment in connection with a loan transaction is usually to determine the property s fair market value Appraisals for other purposes may be used to establish other types of values For example, appraisal for property insurance purposes may be to establish replacement value Market Value Definition Market value is the most probable price which a property should bring in an open and competitive market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably and assuming that the price is not affected by undue stimulus Staff and Fee Appraisers Staff appraisers In-house appraisers, usually employees of the lender Often paid on a salary basis More common with commercial banks, savings banks Fee appraisers Independent contractors Paid on a per appraisal basis Used by mortgage companies, FHA, VA May be used by commercial banks, savings banks Appraisers: License requirements Since FIRREA, appraisals for federally-related transactions must be made by licensed appraisers In California, appraisers are licensed by Office of Real Estate Appraisers (OREA) Website: www.orea.ca.gov Types of Licenses in California Certified General Certified Residential Residential Trainee Certified Residential Levels of Appraiser Licenses Residential may appraise: 1-4 family residential valued to $1 million Other residential, non-residential valued to $250,000 Certified Residential may appraise: 1-4 family residential of any value Other residential, non-residential valued to $250,000
Certified General may appraise: Any real property of any value Trainee may appraise: None independently, but may assist with appraisals within scope of supervising appraiser s license License Requirements: Trainee License License requirements effective 1/1/2008 : None required 150 classroom hours, including 15 hours on Uniform Standards of Professional Appraisal Practice Hours must be in specific topics (modules) License Requirements: Residential License 2000 hours of appraisal experience must be obtained over no less than 1 year 150 classroom hours, including 15 hours on Uniform Standards of Professional Appraisal Practice License Requirements: Certified Residential License 2,500 hours of appraisal experience must be obtained over no less than 2 ½ years 200 classroom hours, including 15 hours on Uniform Standards of Professional Appraisal Practice Associate degree License Requirements: Certified General License 3,000 hours of appraisal experience, including at least 1,500 hours in non-residential must be obtained over no less than 2 ½ years 300 classroom hours, including 15 hours on Uniform Standards of Professional Appraisal Practice Four-year degree Appraisal Reports Appraisals on single-family properties typically use Fannie Mae/Freddie Mac Uniform Residential Appraisal Report Older version of form on text pages 186-187 Appraisals on commercial property use restricted report or self-contained report Appraisal Process Appraisal determines value using three approaches to value Sales comparison (market) approach Cost approach Income approach or gross multiplier (often used for single-family) Appraiser reconciles three approaches
Sales Comparison Approach Uses principle of substitution Buyer should not pay more for home than cost of equally desirable substitute Appraiser researches for sales of recently sold comparable properties [3 or more] Sources: MLS, public records, appraiser s files, real estate agents Adjustments to Comparables Appraiser adjusts for differences between comparables and subject property Adjusts sales prices of comparable properties to determine value of subject property If comparable has better feature, subtract value of feature from comparable s sales price If comparable has better feature, subtract value of feature from comparable s sales price Appraiser reconciles adjusted sales prices to get one final market approach value Examples of Adjustments Subject property has 3 bedrooms 1 ½ baths, fireplace Comparable 1 property has 3 bedrooms, 2 baths, no fireplace Comparable 1 sold for $550,000 Value of ½ bath: $15,000 Value of fireplace: $3,500 Examples of Adjustments Adjustment for bathrooms: Comparable property has better feature; adjustment is a (-) adjustment to comparable sales price Adjustment for fireplace: Subject property has better feature; adjustment is a (+) adjustment to comparable sales price Cost Approach Steps: Estimate the cost of rebuilding structure Estimate depreciation (loss of value from any cause): physical deterioration Items worn out, needed repairs, structural problems functional obsolescence Design not currently in demand, poor floor plan economic obsolescence Factors beyond boundaries of subject property Subtract depreciation from structure cost Add estimated land value Income Approach Six steps: Estimate a vacancy and rent loss Estimate gross annual income Estimate operating expenses, replacement reserves Calculate net operating income Select capitalization rate Divide NOI by cap rate to get value Gross Rent Multiplier Substitute for Income approach Used for single-family homes, small income properties Does not factor in differences in expenses, vacancies Uses ratio of sales price and rents of comparable properties to estimate price of subject property Gross Rent Multipliers Find comparable properties that have recently sold Determine gross rents for the comparables Multiplier = sales price rents Example: Sales price = $400,000, monthly rent = $2,500, Gross rent multiplier = 160
Multipliers can use annual or monthly rents Gross monthly rental multiplier = sales price gross monthly rents Gross annual rental multiplier = sales price gross annual rents Using Gross Rent Multiplier to Determine Value of Subject Appraiser uses gross rent multiplier to determine value of subject property by multiplying gross rent multiplier times projected gross rent from subject property Gross rent multiplier x rents = value Use monthly rents with gross monthly rent multiplier Use annual rents with gross annual rent multiplier Three Approaches to Value: Final Reconciliation After determining the indicated values using the three approaches, the appraiser must reconcile the value from the three approaches to get a final value The appraiser should give weight to the approach or approaches that the appraiser believes is the most accurate for the type of property For example, sales comparison approach usually given most weight if property is single-family home Appraisals of condominiums and other common interest developments Appraisals of individual units in condominiums and other common interest development ("Planned developments" in California, not planned unit development) require additional appraisal considerations, such as: Project appearance Percent of units occupied as second homes or by tenants Adequacy of homeowner assessments Adequacy of parking Appraisal Underwriting Issues Most common issue is a low appraisal LTV uses smaller of sales price or appraised value If appraised value less than sales price, borrower may need to make larger down payment Example: if borrower wanted 80% loan on property selling for $500,000, loan would be $400,000 If appraised value is $480,000, 80% LTV loan is $384,000 Other common appraisal issues are repair requirements, property below minimum standards Working With Appraisers Home Valuation Code of Conduct (HVCC) adopted by Fannie Mae and Freddie Mac Appraisals must be ordered by the lender, by someone who is independent of the loan production staff Real estate licensees and mortgage brokers cannot be involved in the selection of the appraiser or order appraisals Appraisal Management Companies (AMC) are not required, but permitted to manage the appraisal process The appraiser cannot be paid directly by the borrower, real estate licensee, or mortgage broker California law prohibits parties from improperly influencing appraiser Does not prevent asking an appraiser to: Consider additional, appropriate property information Provide further detail or explanation for the appraiser's value conclusion Correct errors in the appraisal report