Transcript Chapter 13

REAL ESTATE FINANCE
PRESENTATION 8
Chapter 13
Qualifying the Borrower
Qualifying the Borrower
• Before agreeing to make a real estate loan, a lender
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will evaluate both the borrower’s ability and
willingness to repay the loan, and whether or not the
property is of sufficient value to serve as collateral for
the loan.
This evaluation process is called LOAN
UNDERWRITING. TQ
The individual who conducts this process is called an
UNDERWRITER. TQ
The primary concern of the underwriter is to
minimize the amount of the lender’s risk.
I. FHLMC/FNMA
Underwriting Standards
Freddie Mac/Fannie Mae
Underwriting Standards
• According to the Freddie Mac:
“underwriting mortgage loans is an art, not a
science. It cannot be reduced to mathematical
formulas, but requires sensitive weighing of the
many aspects of the loan.” TQ
• There are many factors related to the
borrower’s loan application that an underwriter
will consider; they will all relate to income, net
worth, and credit history.
A. INCOME
• Conventional lenders consider a borrower’s income
adequate for a loan if the proposed payment of principal,
interest, taxes, and insurance does not exceed 28% of his
or her stable monthly income.
• STABLE MONTHLY INCOME TQ
• DEBT SERVICE = DEBT TO INCOME TQ
DEBT RATIOS MADE TO EXCEED?
• 28/31 means i.e., min down max LTV
– 20% Down Payment
– 80% Loan To Value
• What about more down???
– 40% Down Payment
– 60% LTV
– 50% Down / 50% LTV
• DTI RATIO CAN BE EXCEEDED UP TO 55% TQ
WHAT???
• YOU heard right
– Why can rules be broken?
– Risk Factor is decreased
– Really? You gonna’ put 50% down
• You probably have even more reserves
• You probably have super FICO score
• You DEFININTELY don’t want to lose investment!!
What about higher FICO?
• Better credit scores mean higher DTI probably
– A little better probably a little higher
– A lot better, a bit more higher probably
• Still more $$ is a better risk factor
• Credit scores can go up and down
• $$$ Talks
NOTE: THIS IS LIKELY, NOT GUARANTEED!!!
1. Stable Monthly Income
• As mentioned earlier,
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stable monthly income is
the base income of the
borrower, plus earnings
from acceptable
secondary sources.
Before concluding there is
a sufficient quantity of
income, the underwriter
must decide what portion
of the total verified
earnings are acceptable as
a part of his or her stable
monthly income.
• IT’S ALL FULL DOC!!!!! TQ
– Quality
– Durability
– Bonuses, Commissions, and
Part-Time Earnings
– Overtime
– Unemployment (if regular)
and AFDC
– Alimony, Child Support, or
Maintenance
– Income from Other Family
Members
– Self-Employment Income
– Co-mortgagor
– Rental Income
– Verifying Income
FULL DOC – WAS’ DAT?
• It means all income and assets and everything
else will be backed up with: TQ
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Bank statements
Paystubs, W-2’s, 1099’s, 1040’s, etc.
Audited P & L & Bal. Sheet (Year To Date)
Divorce settlements (for $$)
Appraisals
Rent Surveys
You name it!
2. Computing Monthly Earnings
• When converting hourly wages to monthly
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earnings, multiply the hourly wage by 40 (hours
in a work week), then multiply by 52 (weeks in a
year) and divide by 12 (months in a year)
Monthly=HOURLY X 40 X 4.333 or YEARLY / 12
• Example:
Hourly Wage: $20.00 x 40 x 4.333 = 3466.67
Weekly Income: $20.00 x 40 = $800
Annual Income: $800 x 52 = $41,600
Monthly Income: $41,600 ÷ 12 = $3,466.67
3. Employment History
• When evaluating the elements of a borrower’s
income (quantity, quality, and durability), the
underwriter will analyze the individual’s employment
stability using the Request for Verification of
Employment, and/or Paystubs for 30 days TQ
• Annual income for 2 years, i.e., 2 years 1040’s
• A borrower with a history of steady, full employment
will be given more favorable consideration than one
who has changed employers frequently, unless the
changes are properly explained.
• As a general rule, a borrower should have continuous
employment for at least two years in the same field.
4. Advancement
• If the borrower has changed employers for
the sake of advancement within the same line
of work, the underwriter will likely view the
change favorably. TQ
• On the other hand, persistent job hopping
without advancement usually signifies a
problem of some kind and an underwriter will
tend to regard the individual’s earnings as
unstable. TQ
5. Education and Training
• Special education or training that prepares an
individual for a specific kind of work can
strengthen a loan application.
• Such education or training can offset minor
weaknesses with respect to earnings or job
tenure if the underwriter is convinced there is
a continuing demand for individuals in this
line of work.
B. NET WORTH
• According to Fannie Mae, “accumulation of
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net worth is a strong indication of credit
worthiness.” TQ
A borrower who has built up a significant net
worth from earnings, savings, and other
investment activities clearly has the ability to
manage financial affairs and accumulate
wealth.
An individual’s NET WORTH is determined
by subtracting personal liabilities from total
assets.
1. Required Reserves After
Closing
• As a safeguard against unexpected bills or temporary
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loss of income, and as a general indicator of financial
ability, Fannie Mae requires the borrower to have
sufficient cash on deposit, or in the form of highly
liquid assets, to cover two months’ payments (PITIM)
after making the down payment and paying all
closing costs.
AUTOMATED U/W (DU-Desktop Underwriter) findings
will be the guideline ultimately. TQ
FHLMC guidelines require a minimum of two months’
payments for all owner-occupant loans, without
regard to loan-to-value ratio, and three to six months
for non-owner-occupant loans.
INVESTMENT PROPERTY
RESERVES
• Investment Property = Non Owner Occ.
• 6 months reserves for rental TQ
– And for each rental with a loan on it
– Yep 3 rentals = 18 months reserves
• 2 months reserves for residence & any 2nd
home (owner occupied – vacation home)
2. Verification of Assets
• Included in every loan application is a
section devoted to assets. TQ
• The underwriter will take whatever
steps are necessary to verify the nature
and value of assets held by the
borrower.
• LIQUID ASSETS
• NON-LIQUID ASSETS
3. Verification of Deposit
• The underwriter will use the Request for
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Verification of Deposit form to prove the
borrower has the necessary funds in his or
her bank account(s).
This form is sent directly to the bank and
returned to the underwriter without passing
through the borrower’s hands.
Used less often now, than bank statements
TQ
4. (Previously) Alternative,
now the Usual Verification
Method TQ
Lenders may use an alternative method
of verifying deposits: the borrower may
submit the original bank statements for
the previous two months to verify
sufficient cash for closing.
• 2 months per account being verified
5. Financial Statement
Self Employed or Multiple Incomes
• If a borrower’s assets are substantial and
diverse, an audited financial statement may
be the best way to explain the borrower’s
creditworthiness to the underwriter.
• A FINANCIAL STATEMENT is a summary of
facts showing the individual’s financial
condition; it contains an itemized list of assets
and liabilities which serves to disclose net
worth.
6. Real Estate for Sale
• If a borrower is selling a property to raise
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cash to buy the subject property, the equity
may be counted as a legitimate asset,
SUBJECT TO closing that sale!
EQUITY is the difference between the
market value of the property and the sum of
the selling expenses, mortgages and other
liens against the property. TQ
Equity is what the buyer should receive from
the sale of the property.
7. Other Assets
• Any assets held by the borrower will help the
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loan application.
Assets, other than cash and real estate,
typically listed in a loan application include
automobiles, furniture, jewelry, stocks and
bonds, and cash value in a life insurance
policy OR retirement fund.
8. Gift Letter
• If an applicant lacks the necessary funds to
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close a transaction, a gift of the required
amount from relatives is usually acceptable to
the underwriter.
The gift WILL be confirmed by means of a
(gift) letter signed by the donor.
The letter should clearly state that the money
represents a gift and does not have to be
repaid.
There is a form for this!!
Also, evidence of donor’s ability to give will be
required!! TQ
C. CREDIT HISTORY
• As a part of the loan evaluation, the underwriter will
analyze the credit history of the borrower; this is
accomplished by obtaining a credit report from a
responsible credit rating bureau.
• A high FICO credit score is the standard by which a
borrower’s creditworthiness is determined. TQ
• Here are some helpful hints to increase your credit
score:
1. Pay bills on time.
2. Limit outstanding debt.
3. Have a long credit history.
4. Restrict your credit.
5. Too much credit.
Figure 13-7
1. Explaining Derogatory Credit
• LESS IMPORTANT NOW THAN EVER DUE TO FICO’s
TQ
• Most people try to meet their credit obligations on
time; when they do not, there is usually a reason.
• A loss of job, hospitalization, illness, death in the
family or even divorce can create extraordinary
financial pressures and adversely affect a credit
report.
• It may be possible to successfully explain the ratings
if the borrower can show that the problems occurred
during a specific period of time for an understandable
reason, and that prior and subsequent credit ratings
have been good.
2. Bill Consolidation, Refinancing
• Even in the absence of derogatory ratings,
there are matters that can be revealed by a
credit report which might indicate the
borrower is a marginal credit risk.
• If an individual’s credit pattern is one of
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continually increasing liabilities and
periodically “bailing out” through refinancing
and debt consolidation, he or she may be
classified as a marginal risk.
The pattern suggests a tendency to live
beyond a prudent level.
3. Illegal Discrimination
• A borrower must be of legal age (18) before
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he or she can qualify for a loan; after that, an
applicant’s age is not a valid reason for
rejecting a loan.
NO MATTER HOW OLD WE ARE!!! TQ
Your life expectancy is NOT a factor!!!!!
In addition to age, a lender cannot use as a
basis for denying a loan the race, color,
creed, national origin, religion, handicap,
familial status, marital status, or sex of the
borrower. TQ TQ TQ
Figure 13-8
Qualifying a borrower Summary
• The loan underwriting process evaluates both the property and the
borrower’s willingness and ability to pay off the loan.
• An underwriter will make a determination of these factors by
analyzing the borrower’s current income, debt levels, overall net
worth, and credit history.
• For conventional loans, these will be the guidelines of FNMA
(FANNIE MAE) and FHLMC (FREDDIE MAC).
Chapter 14
Qualifying the Property
Valuation
Broker Price Opinion
Appraisal
I. The Lender’s
Perception of Value
APPRAISAL
Lender’s Perception of Value
• Lenders utilize Licensed and Certified Appraisers to
provide a professional opinion of market value for
each residence they loan upon.
• By both state and federal law appraisers are required
to provide an unbiased and independent analysis of
the property. TQ
• MARKET VALUE is the price paid by a typical buyer;
it is based on the analysis of a group of actual sales
that occurred in the marketplace.
• It is this true market value that a lender seeks,
because if a foreclosure is ever necessary, the lender
has some assurance that the property can be sold for
an amount that can enable them to recover most, if not
all, of their investment.
A. LTV AND MAXIMUM LOAN
AMOUNT
• Loans are generally made at a loan-to-value ratio of from 80% to
90% of the value of the property. Example:
• $180,000.00 Sales Price
• $150,000.00 Appraised Value
• $150,000.00 Appraised Value
• x .80 Loan to Value Ratio
• $120,000.00 Maximum Loan
• In the example, the maximum loan is predicated on the lower
appraised value, not the higher sales price.
• If the lender were to base the loan on the higher of the two figures,
it would be loaning an amount that would be 96% of the appraised
market value.
B. ESTIMATING MARKET VALUE
• It is not necessary for agents and loan officers
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to be able to appraise properties, BUT it is
NECESSARY TO DO A VALUATION!! TQ
However, it is helpful to understand the
mechanics of the appraisal process and to know
something about the reasoning and logic that
underlies many of the appraiser’s conclusions.
For real estate agents, an understanding of how
lenders and their appraisers perceive value will
enable them to write and arrange financing for
sales that will hold together.
II. Market Approach
This is the only way value is determined.
Yes, appraisals have “replacement value”
or “cost of construction” BUT the value
that is used is MARKET VALUE! TQ
Market Approach
• The market approach to value is the most easily understood by the
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layman.
The MARKET APPROACH involves a comparison of the property
being appraised against other similar properties in the same
neighborhood that have recently sold or are currently being offered
for sale AKA “COMPS”. TQ
Appraisers know that no informed buyer who is acting free of
pressure will pay more for a particular property than he or she would
have to pay for an equally desirable substitute property.
An informed seller is not likely to sell for less than is necessary, and if
he or she is objective, the selling price will be based on the results of
recent sales in the neighborhood.
The property sales that appraisers actually use are those that have
closed escrow.
A. IDENTIFYING LEGITIMATE
COMPARABLES
• When utilizing the market approach, the
appraiser must be certain that the sales
used as a basis for comparison are, in
fact, relevant in terms of the factors that
have the most impact on value
1. Metropolitan Statistical Areas
• A METROPOLITAN STATISTICAL AREA is an
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area with a core city population of 50,000
people and the area surrounding it.
The information obtained from these areas is
considered to be significant to business, industry
and consumer groups.
Bar graphs may be combined with a frequency
curve to provide what is known as a
HISTOGRAM.
• FREQUENCY CURVES
• BELL CURVE
2. Multiple Regression Analysis
• Another tool consists of the use of MULTIPLE
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REGRESSION ANALYSIS, which is a statistical
procedure that attempts to assess the
relationship between a dependent variable and
two or more independent variables.
THIS IS ALSO KNOW AS “FANCY B.S.”
3. Automated Valuation Models
• Currently, NOT a popular tool for the selection of
comparable sales, the AUTOMATED VALUATION
MODEL (AVM), which is a computer generated
valuation report, THAT WAS the darling of the
lending industry FOR 5 MINUTES! TQ
• Many residential lenders accept AVM reports in lieu of
traditional appraisals for both first and second
mortgages.
• An AVM can review and select from hundreds of
properties within seconds.
• If the AVM is combined with a regression analysis
program it can provide a bottom line value in
seconds.
AVMs (cont.)
• Well, it turns out that most AVMs are only accurate
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about 65% of the time.
All economic and appraisal modeling programs require
proper calibration by the user.
In addition, the raw data put into many models is
often unverified and incorrect. For example, most
county data is anywhere from 10-15 years old and
may not include homeowner upgrade information.
The AVM program assumes that every residence in
your area is of the same quality and condition.
The question might be asked: “Why do we need an
appraiser?”
4. Appraiser Assisted AVMs
• To try to answer these problems the industry
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has developed the APPRAISER ASSISTED
AUTOMATED VALUATION MODEL (AAAVM).
These programs are modified to allow an
appraiser to manually input information, make
some adjustments, and do minimal calibration.
Also, the appraiser signs off on the result which
takes care of who is liable for the accuracy of
the AVM.
NOT A TQ ISSUE!!!! NOT TQ…….
5. Sale Date of the Comparable
Sale
• The sale should be recent—within the
past six months, if possible.
• Recent sales are used because they
most accurately reflect what is
occurring in the current market and do
not require adjustments for time.
BROKER PRICE OPINIONS
• “Cheap” appraisals that lenders order from us
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brokers who want to make $20 an hour (or less)
on average. TQ
Use comps 3 mos or less old, within 1 to 3 miles
(depending on rural, urban, or suburban…which
is flexible), within 20 to 25% of the GLA (gross
living space) and a reasonable variation of lot
size, and age construction (year built) TQ
BROKER VALUATION
• Generally do your own “BPO” (you just
don’t get paid for it until the listing sells
• Used to estimate value of a listing
• Follow same guidelines
• Aka “Comparative Market Analysis”
• All of the above are TQ issues.
6. Location of the Comparable
Sale
• Comparables should be selected from the
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neighborhood of the subject property.
In the absence of any legitimate comparable
sales in the neighborhood, the appraiser can
select comparables from nearby similar
neighborhoods. TQ
Care must be taken that the properties and the
neighborhoods have similar physical and
demographic characteristics.
7. Physical Characteristics
• To qualify as a comparable, a property should
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have physical characteristics that are essentially
similar to the subject property. TQ
That is, for example, compare two story homes
to two story homes…dome homes t dome
homes (oops, this is known as a “nonconforming construction”)…seen many of them
around? TQ
8. Terms of Sale
• With the increase of seller participation in financing
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today, the terms of sale have become much more of a
factor when estimating value.
Buyers have demonstrated a readiness that often
borders on foolishness to pay inflated prices for housing.
Often, eager sellers offer to pay a % of the sales price in
“closing costs or pre-paid expenses” while adjusting the
price of the house upwards to recover the difference in
interest. TOTALLY LEGAL, but has limits. TQ
The appraiser is required to research the terms of sale of
comparables to determine what influence they had on
the sale price.
The above referenced closing costs assistance is the
most common seller participation in our area.
9. Arm’s Length Transaction
• Before a sale can be relied upon as an
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indication of what the subject property is
worth, it must be an ARM’S LENGTH
TRANSACTION.
This means that buyer and seller are both
well informed, under no pressure to either
buy or sell, and that the property is offered
for a reasonable time on the open market.
• AND probably are not related to each
other!!! TQ
III. Cost Approach
REQUIRED TO BE ON THE APPRAISAL FORMS USED
FOR FNMA, FHLMC, FHA, VA OR ANY OTHER
CURRENT TYPE OF LOAN…..NOT USED BY THE
UNDERWRITER TO DETERMINE VALUE OR RISK IN
99% OF SITUATIONS!! TQ
Cost Approach
• The cost approach is based on the presumption that
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buyers will not pay more for an older property than the
cost of purchasing a newly constructed residence at
the site.
Residential appraisers keep abreast of current
construction costs in their areas and refer to them
when using the cost approach.
There are three steps in the cost approach:
1. Estimate the cost of replacing the house with a new home that is similar
to the existing one utilizing the information from the cost handbook.
2. Estimate and deduct accrued depreciation from all sources.
3. Add the value of the lot to the depreciated value of the house.
(cont.)
• The appraiser will then deduct all sources of
accrued depreciation from the cost new.
• Appraisers also make adjustment on the
presumption that a used home is not as
valuable as a new home and that it may have
suffered a loss in value for one of the following
reasons:
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PHYSICAL OBSOLESCENCE
FUNCTIONAL OBSOLESCENCE
ECONOMIC OBSOLESCENCE
CURABLE/ NOT CURABLE
– TRULY IS PART OF PROCESS TQ
IV. Income Approach
THIS IS AN IMPORTANT PART (ONLY) OF A “NONOWNER OCCUPIED” OR “INVESTMENT” PROPERTY! TQ
Income Approach
• The majority of single-family residences are not income producing
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properties (rentals), so traditional income analysis and appraisal
techniques do not apply.
However, some single-family residences are rented, for which lenders
will request an income approach.
Generally, this is provided by using a GROSS RENT MULTIPLIER
(GRM) which is determined by dividing the sales price of a series of at
least three recent sales of similar single family rental properties by
their monthly rental income.
Example: Sales price $100,000 ÷ $900 monthly rent = 111
gross rent multiplier.
The appraiser will then select a multiplier from the range that has been
developed.
He or she will then multiply that multiplier by the subjects rent to
determine the value by the income approach.
RENTAL SURVEY/INCOME
ANALYSIS
• THIS IS AN ADDENDUM WHICH MUST BE
ORDERED AND PAID EXTRA (ABOUT
$100-150) ON ANY INVESTMENT
PROPERTY APPRAISAL TQ
V. Understanding the
Appraisal Process
NEW LAWS APPLY TO THE APPRAISAL PROCESS
•ONE IS THE “HVCC” LAW
•This law requires lenders to order
appraisals thru a 3rd party TQ
•The purpose is to avoid any pressure
(which was already illegal) by a loan officer
or lender on the appraiser to reach a value
that the lender wanted “or else”. TQ
•The net result, more expensive appraisals; slower appraisals;
more re-inspections by appraisers…..all adding extra expense
and delay to the process…. TQ
Real Estate Settlement Procedures
Act TQ
• This is the law that the HVCC was added
to
• It already was illegal to pressure
appraisers, but now it’s more expensive
too!
• A great example of the government
“helping” us!
Understanding the Appraisal Process
• Real estate agents and loan brokers need to
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understand the basic steps in the appraisal
process because it will help them eliminate, or at
least minimize, a prevalent problem that has
plagued the industry—both agents and loan
brokers tend to overvalue properties.
SEE PREVIOUS SLIDES
A. HOW TO SOLVE PROBLEMS
CAUSED BY LOW APPRAISALS
• Of course the best way to eliminate the problems created by low
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appraisals is to avoid them in the first place by pricing properties
realistically.
A seller should not be given an unrealistic estimate of his
property’s worth. TQ
Regardless of how objective an appraiser may be, there are some
subjective considerations and conclusions in every report. TQ
An appraisal is an opinion of value. TQ
If you are affected by a low appraisal and sincerely believe that
the appraiser has made a mistake, you can appeal his or her
decision and, with the proper documentation sent to your lender,
get the appraisal increased, possibly to the figure originally
requested. TQ
VI. Key
Considerations to a
Residential Appraiser
• There are many
things to consider
during the
residential appraisal
process.
• Some of them are
very important,
others are not.
• The following is a
summary of property
features that are
considered
important by
appraisers.
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Location
Owner-Occupied
Vacancies
Rental Levels
Construction Activity
Conformity
Changing Land Use
Size and Shape of Lots
Contour of the Land
Street Patterns
Utilities
Nuisances
Proximity to Services
Zoning
Site/View
Design and Appeal
Construction Quality
Age/Condition
Functional Utility
Energy-Efficient Items
Room Count
Square Footage
VII. Rural and
Suburban Homes
PART OF APPLE VALLEY AND HESPERIA AND
VICTORVILLE; PHELAN; PINON HILLS….ALL ARE
PARTIALLY AT LEAST THE ABOVE….THE OTHER
SELECTION WOULD BE “URBAN” . IT APPEARS THAT
PART OF VICTORVILLE COULD BE CALLED URBAN,
BUT IT’S A JUDGEMENT CALL REALLY. FYI NOT TQ
Rural and Suburban Homes
• Properties in outlying areas are eligible
for maximum financing by both the
primary and secondary market subject to
the following conditions.
1. The value of the land is not more than 49% of the
overall value of the property.
2. There are adequate public or private utilities in
service on the property.
3. The property is accessible by a federal, state, or
county highway or an all-weather secondary road.
4. The present or anticipated use of adjacent real
estate does not unfavorably affect the value of the
property as a residence.
VIII. Atypical Property
and Loan Types
Atypical (NON CONFORMING)
Property and Loan Types
• ATYPICAL PROPERTIES, which are also
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called non-conforming properties, include,
but are not limited to, manufactured homes,
dome homes, and log cabins.
These must be appraised by a Certified Level
Appraiser only.
Licensed Level Appraisers are only permitted
to appraise conforming properties and loans.
Alert
IX. CHAPTER SUMMARY
• Lenders demand professional appraisals because they want an
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entirely objective opinion of the true market values of the properties
they loan upon.
Loan-to-value ratios are based on the sales price or the appraised
value, whichever is lower.
All appraisers, and those who use their appraisals for federal loan
transactions, must adhere to the Uniform Standards of Professional
Appraisal Practice (USPAP) as well as state and federal lending and
appraisal regulations. The appraiser is required to follow the
appraisal process.
For loans, the appraiser is asked to determine the “Market Value” of
the property. This is a specifically defined value that may be either
higher or lower than the actual selling price of a property.
HONEST AND ETHICAL PRACTICES CAN ELIMINATE THE NEED FOR
OVERREGULATION BY GOVERNMENT IN MY OPINION…..THINK
Chapter Summary (cont.)
• Appraisers use the market approach, the cost approach, and the income
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approach when valuing properties.
The market approach is the most useful for residential properties, as it
reflects what actually is occurring in the marketplace. Comparables used
in this approach should be recent sales in the same general neighborhood
or area as the subject and as similar to the subject as possible. They
must be real closed sales at “arm’s length.”
The cost approach is carried out with the use of cost handbooks.
Appraisers estimate the overall accrued depreciation of a property by
taking into account any physical, functional, or economic obsolescence
that it may have incurred.
The income approach is seldom used unless the property is a rental.
Then a Gross Rent Multiplier is used to determine value.
It is useful for agents, brokers, and others to understand the
appraisal process in order to keep from overvaluing properties
and losing sales as a result. TQ