Usually, individuals applying for a loan are only interested in obtaining the loan and unfortunately are not worried about the prudence of buying the property at the agreed price. In fact, many purchasers will try to encourage appraisers to increase the appraised value so that they can purchase the home regardless of its value.
The majority of real estate appraisals are requested by lenders to establish the property's value for loan purposes. Except for periods of very low interest rates when everyone is refinancing, most loans are for the purchase of real estate; thus most appraisals are ordered after a sale price is negotiated. Purchasers assume that lenders are looking after their interests, but are they?
If the lender orders the appraisal, the appraiser is responsible only to the bank. The law requires that the lender order the appraisal, and the lender must be the client. We expect lenders to be prudent and they should be, but being prudent is protecting their interest, not necessarily the purchaser's.
The lender's and the purchaser's position in a purchase transaction can be compared in this manner:
- Lender: has two sources of repayment: the purchaser's income and the property.
- Purchaser: is obligated to pay the note even if the property value declines to zero; because responsibility to repay the loan is not based upon the property's value.
- Lender: may have the loan insured or guaranteed by a government agency.
- Purchaser: does not have the promise of government to pay the purchaser's debt if property value is wrong.
- Lender: if loan is greater than 80% of the value, a portion of the loan may be insured by a private mortgage insurer.
- Purchaser: there is no decrease in risk, regardless of loan-to-value ratio. The investment by the purchaser is the same, a mixture of personal cash and a loan that must be repaid.
- Lender: rely on percentages as a hedge against losses and expect a certain amount of loss.
- Purchaser: individual does not have the ability to leverage by the percentages. The inability to pay for the property or repay just one real estate loan will be enough to create an insurmountable financial burden for most people.
- Lender: The lender is not required to have an appraisal by a qualified licensed or certified appraiser if the transaction amount (loan) is $250,000 or less.
- Purchaser: unless financial picture is different than most, payment on a $100,000 home is significant, not to mention the payment on a quarter of a million dollars ($250,000).
- Lender: is using other people's money.
- Purchaser: is using personal funds, not someone else's.
So the lender can afford to be wrong several times, but can the purchaser afford to be wrong just one time? This is not to imply that there is something jaded about the lender's position; it is no more biased than our own.... but, the purchaser needs to be aware of the circumstances so that his or her position is protected.