The Need for a Home Score for Mortgage Transactions

The condition of a property has been a long-established factor in determining value, but was broadly minimized during the prior residential real estate period of hyper-price inflation.

During that period, property condition generally was overlooked as the underlying land value often drove the valuation where property condition was poor. When values plummeted, many homeowners and investors simply neglected or deferred property maintenance. This was particularly true when the property was under water and the homeowner found it hard to invest additional, or even spend moderate, amounts on upkeep that wouldn’t translate into returnable dollars. At one point, it was estimated some 11 million homes were under water. Consequently, a significant portion of the housing stock has deferred maintenance at varying levels.

In a managed effort to achieve better information about property condition and to drive the appraiser to be more cognizant of property condition in determining market value, under a directive from FHFA, the GSE promulgated new scoring requirements regarding property value in the appraisal form and required appraisers to comment on property condition. Regrettably, this approach makes the review and consideration of property condition totally by appraiser observation. Appraisers do not conduct property inspections in the full technical sense that home inspectors do. Appraisers simply review room sizes and make observations regarding any obvious property issues to make certain the description of the property provided to them is correct so that they may properly perform a market analysis of comparable properties. Appraisers do not carry ladders, climb to the roof, perform thorough systems checks or carefully review for structural and other issues. This in-depth review of property condition is left to the home inspector.

Regrettably, the wording in the appraisal form regarding property condition implies that the appraiser reviewed the property condition. Most home purchasers, particularly those buying a property for the first time, do not readily understand the difference between an appraiser and a licensed home inspector. Consequently, many home purchasers who dutifully receive a copy of the appraisal from their lender likely will interpret the wording in the appraisal as full and complete statements regarding property condition.

The existing regulations and the proposed additional requirements regarding property condition have skirted the home inspection industry and were developed without any input from the industry or the leading professional society of home inspectors — the American Society of Home Inspectors (ASHI). ASHI sees the need and is in the process of developing a specialized mortgage financing inspection that would provide appropriate data standards and possibly serve as a more complete guide for appraisers and lenders.

ASHI understands that the Consumer Finance Protection Bureau’s mission is to develop and enforce appropriate rules and regulations regarding finance so that the consumer makes an intelligent and informed decision about financing. Yet, without a complete and thorough inspection of the dwelling, there’s simply no way any lender, the lender’s appraiser or the homebuyer can make an intelligent, informed decision. For example, if one of the core systems in the home is faulty, in need of early replacement or repair, shouldn’t that condition be considered by the homebuyer before incurring substantial mortgage debt? And, if the prospective borrower has marginal cash reserves, wouldn’t the lender likely want the core system repaired or replaced prior to closing … or require adequate funds to be provided by the seller or built into the loan amount?

If one had a clean sheet of paper and was designing the home financing process from scratch to assure that all parties to the financing transaction were properly informed about all aspects of the property posted as collateral, and fully recognizing the roles, responsibilities and capabilities of the parties to the transaction, a home inspection would be the first required step toward determining value, with the appraiser then required to review and consider that inspection in his determination of market value. This process would be applicable for all mortgage financing transactions, including refinancing.

Despite the short period of time the new UAD (Uniform Appraisal Dataset) Fannie Mae and Freddie Mac regulations have been in effect, several homebuyer suits already have been filed against appraisers because the homebuyer viewed the appraisal as including a complete review of the dwelling structure and systems. Further, issues surrounding the lack of clarity about property condition are expected to develop over time as homebuyers and homeowners see a blurring distinction between home inspectors and appraisers with respect to making informed judgments about property condition.

The harsh reality of financing and valuation markets is that they are data-based and that regulators must rely on solid data to provide appropriate information to determine policy and regulation. Thus, embracing some appropriate data and report standards for a mortgage financing inspection report, including a scoring methodology, is critical for the future of the home inspection industry.

Finally, it is important to recognize that, in 2012, approximately 80 percent of the mortgage loan transactions involve refinancing. Refinancing has averaged more than 50 percent of total mortgage transactions for the better part of the last decade. Industry inspection volume would materially increase if lenders required a home inspection or a home score prior to ordering an appraisal.

Next month: The Value of Home Inspection Scoring Methodology.