The OCC, Federal Reserve Board, and FDIC (collectively, the agencies) have adopted a final rule (effective April 9, 2018) to amend the agencies' regulations requiring appraisals of real estate for certain transactions. The final rule increases the threshold level at or below which appraisals are not required for commercial real estate transactions from $250,000 to $500,000. The final rule defines commercial real estate transaction as a real estate-related financial transaction that is not secured by a single 1-to-4 family residential property. It excludes all transactions secured by a single 1-to-4 family residential property, and thus construction loans secured by a single 1-to-4 family residential property are excluded. For commercial real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

View the Final Rule

View the Appraisal Institute's Comments on the Proposed Rule

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Issue

Per the Economic Growth and Regulatory Paperwork Reduction Act the Federal bank regulatory agencies have been reviewing whether to raise the appraisal threshold levles, which currently stand at $250,000 for real estate loans and $1 million for business or owner occupied loans. Testimony on September 28th by Federal Reserve Chair Janet Yellin to the House Financial Services Committee signaled the agencies' intentions to propose a reduction in appraisal requirements, perhaps before the end of 2016. This would reduce fundamental risk management requirements at a time when the housing market has only recently recovered from the largest real estate related financial crisis in several decades, and in the face of alarm bells transmitted by the regulators about the commercial real estate market.

Background

FIRREA, enacted in 1989 in response to the savings and loan crisis, authorized Federal bank regulators to require appraisals for real estate loans made by federally regulated financial institutions.

• In 1994, the bank regulators exempted wide swaths of loans from appraisal requirements, including real estate loans below $250,000 and owner occupied business loans below $1 million. More than 20 years later, a majority of residential real estate loans still do not require an appraisal under the existing exemption. 
• The recent financial crisis witnessed widespread problems with bank management of appraisal requirements, including adherence with the 1994 regulations. A vast majority of failed banks from the financial crisis were shown to have been cited by federal bank regulatory agencies for lax appraisal management.
• In addition to establishing the two appraisal threshold levels in 1994, the agencies exempted loans sold to Fannie Mae and Freddie Mac. This allowance was granted based on a determination by the bank regulatory agencies that the government sponsored entities would maintain equivalent appraisal requirements. Over time, the government sponsored enterprises loosened their appraisal requirements. 
• Ultimately, nearly 1/3 of loans received an “appraisal waiver.” Coupled with poor underwriting and review requirements, the policies of the government sponsored enterprises drove them into conservatorship by the federal government.
• Since the crisis, the GSEs have required appraisals more often.  A 2011 GAO Report found that 85% of mortgages purchased by the GSEs in 2010 were accompanied by appraisals.  Today, nearly all first purchase mortgages require a full interior inspection appraisal completed by a certified appraiser.

Concern

As independent evidence of the market value of a property, appraisals protect both consumers buying homes and taxpayers who stand behind the GSEs and FDIC-insured institutions. Raising the appraisal threshold above $250,000 would undermine both consumer protection and safety and soundness:

• It would increase the odds that a home buyer will wind up “under water” in a house – owing more in mortgage debt than the home is worth.
• It would increase the odds that the GSEs will package, or that banks and thrifts will hold, mortgages worth less than the home is worth.  Taxpayers would be called upon to make good any losses resulting from defaults and foreclosures – just as they did after the financial crisis.

Indexing the appraisal threshold to inflation would be a back-door increase, because housing values have not tracked inflation.  U.S. housing values are just now reaching their pre-crisis levels, after a steep decline from 2008 to 2012.

The appraisal threshold should be maintained at its current level, as a protection against risky real estate lending.

View the Appraisal Institute's comment letter to the Federal Regulators on the appraisal threshold.

View the National Association of Realtors letter to FFIEC on the appraisal threshold.