First-time homebuyers have a recorded tendency to overpay on their home purchase.
A report by the Federal Housing Finance Agency (FHFA) identifies three reasons for overpayment by first-time homebuyers:
- first-time homebuyers are more eager to purchase than repeat homebuyers;
- they are less likely to identify mistakes in an appraiser’s report; and
- their inexperience can lead to an unwillingness to renegotiate when the appraisal comes in below the agreed-to price.
This isn’t to say first-time homebuyers pay more on average than experienced homebuyers. In fact, first-time homebuyers traditionally purchase less-expensive homes than repeat buyers since they don’t have the advantage of equity built up in a currently owned home. Rather, if a repeat homebuyer were to purchase the same property as a first-time homebuyer, they are more likely to pay a lower price than the first-time homebuyer.
In the study — which was conducted on homes which sold nationwide during 2013-2015 — first-time homebuyers paid 1% more for the same home as a repeat buyer. With the average sales price of $275,000, this comes out to a difference of about $2,600. In California, where home prices are much higher than the national average, the difference is certainly higher.
In cases where first-time homebuyers overpay, the FHFA report points the finger at bad appraisals.
The appraiser’s role
Appraisers are obligated to gather information on the property and its recent sales history, as well as recent comparable sales. They are to report the home’s fair market value (FMV), the price a reasonable and unpressured buyer and seller will agree upon in the open market, both possessing the same knowledge of material facts.
The appraisal is a key factor in this gathering of material facts. When an appraiser makes a mistake, the homebuyer may end up paying too much for their home.
In many cases, the appraiser will arrive at a home value matching the exact price agreed to by the buyer and seller. These exact match appraisals show the appraisers’ desire to see the deal close or just laziness, as a low appraisal means significant financial and economic cost for the buyer and seller.
In the FHFA study, an astounding 29% of appraisals were an exact match for the agreed-to price. Many of these exact-match appraisals are put in by the same appraisers, as some have a tendency to confirm the agreed-to price in many or most of their appraisals. The report says these appraisers are of lower quality as it takes “less cognitive effort” to simply confirm the price.
Other hints that an appraisal is to blame for overpayment are when the appraiser leaves out recent transaction history for the house in question, and when appraisers make errors about key characteristics of the house. In fact, almost half of the appraisals studied included wrong information on the number of bathrooms, bedrooms and square footage.
The FHFA study finds a correlation with appraiser mistakes and a lack of renegotiation following the appraisal. On the other hand, more accurate appraisers are correlated with more renegotiating. Only 5.7% of all homebuyers covered by the study renegotiated the sales price down following the appraisal.
Blame the appraiser
The FHFA study finds that first-time homebuyers are more likely to pay FMV when working with accurate appraisals.
The federal government has worked to improve the appraisal process since it contributed to escalating prices during the Millennium Boom, and the ultimate crash. It now requires appraiser independence.
Appraisals of one-to-four unit residences are overwhelmingly overseen by an appraisal management company (AMC). The AMC puts a buffer between the lender — who has a financial interest in seeing the deal close — and the appraiser — who has the ability to influence the transaction with their determination of the appraised value.
However, AMCs are wrought with inefficiencies and even conflicts of interest (particularly with bank-owned AMCs).
One of these issues is pay.
The AMC operates as an extra “middle man.” True, it offers some independence from lenders, but due to the added buffer, homebuyers often pay more for appraisals and appraisers are paid less. This has resulted in very few new appraisers joining the industry (the average age of an appraiser in 2015 was 58).
Worse, the number one complaint to California’s Bureau of Real Estate Appraisers regarding AMCs is the AMC not paying their appraisers. This complaint is followed by the claim of AMCs attempting to influence an appraisal, which is exactly what AMCs are required to avoid. [Calif. Bus. & Prof. Code §11345.4, Calif. Civil Code §1090.5]
With little pay, appraisers have even less incentive to deliver highly researched appraisal reports.
Blame the buyer (or their agent)
One thing the FHFA study fails to mention is the responsibility of the homebuyer.
The report characterizes first-time homebuyers as inexperienced, doe-eyed sycophants, with little knowledge or ability to concede their financial decisions. But once the deal closes, the party with the most financial stake is always the homebuyer. Thus, the homebuyer has the most motivation to make an informed decision when it comes to the purchase price.
True, during negotiations emotions may run high, and when the purchase price is broken down in monthly installments, the difference of a few thousand dollars doesn’t make much of a dent on the buyer’s monthly balance sheet. their inexperience with negotiations may also have something to do with the documented tendency of first-time homebuyers to overpay.
But overpayment is completely avoidable — even without an accurate appraisal.
Appraisals and accompanying documents are required to be delivered to the homebuyer, regardless of whether the loan actually closes with that lender. [12 CFR §§1002.14 et seq.]
Therefore, the homebuyer has the opportunity — and they are wise to take it — to study the appraisal and documents for errors. Their goal is not to reduce or inflate the value. The homebuyer’s goal ought to be to pay FMV for the home. That’s because when they overpay they are more likely to find themselves underwater and unable to sell when needed.
When the appraisal does include mistakes or significant omissions, homebuyers are able to challenge the appraisal to have it fixed.
But again, first-time homebuyers are inexperienced and don’t know they have the ability and impetus to review the appraisal. That’s where their agent comes in.
Buyer’s agents have the fiduciary duty to advise their buyer’s of the appropriate price to pay for the property in question. This includes informing their clients of their options when an appraiser comes up with a surprising number that doesn’t seem right.
Agents: when was the last time you helped your buyer challenge an appraisal? How often is this successful? Share your experience in the comments below.