Abstract
Using home purchase loan application data, we study buyer responses to the uncommon occurrence of the appraised value coming in below the contract price (i.e. a low appraisal), which sharply raises the probability of downward price renegotiation. We propose that two mechanisms drive the higher renegotiation rates. First, a liquidity channel, visible for financially constrained borrowers for whom a low appraisal impacts financing costs. Second, for financially unconstrained borrowers, we identify a news channel whereby the information content of the low appraisal alone induces borrower renegotiation. Importantly, we show that low appraisals result in lower renegotiated prices through these channels without a substantially lower likelihood of a loan application leading to loan origination or notably longer times from contract signing to sale.
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Notes
Exceptions to requirement for appraisal are applications that receive a Property Inspection Waiver (PIW), available to about 5 % of Fannie Mae purchases after January 2017. Loans with PIWs do not appear in the analysis in this paper, as the focus here is on the relationship between the appraised value and the contract price.
Discussing the consequences of a low appraisal with realtors, we established that, in practice, there is virtually never legal resistance by sellers to a borrower withdrawing from the contract in the case of a low appraisal and obtaining a return of their earnest money deposit.
We also remove cases where the appraisal does not occur at least one day after the data is initially entered into DU. This is in many cases just a matter of delayed entry of the DU underwriting data, however a key statistic in this paper is the effect of a low appraisal on time to close the loan from initial application date. Additionally, we want to be confident that the appraiser was selected by the same lender (potentially through an AMC) who closes the loan and that, for instance, a lender is not using an appraisal provided by the borrower from another pre-existing loan application.
Analysis of the randomly selected 100 contracts was done manually. As such, this is not a method that is replicable for the entire sample of loan applications used in the analysis in order to specifically assess whether the contract is actually cancelled or just renegotiated.
Recall that our sample only includes loan applications that were approved hence, once a lower FICO score borrower’s loan is in our sample, it is more likely to lead to a delivery.
Analysis of mortgage-backed securities (MBS) issuance data from 2013 to 2018 reveals that 7.6% of Fannie Mae purchase mortgages in MBS issuance during this period had LTVs above 95%. This is markedly larger than the share with LTVs above 95% for Freddie Mac issuance, at 3.9%.
Appendix Figure 11 shows analogous charts indicating the rate of upward renegotiation by LTV categories and we can observe that upward renegotiation rates are not related to LTV level in the same way that downward rates are.
Appendix Figure 12 shows analogous charts displaying the percent of the difference between appraised value and contract price that is yielded by the buyer for appraised values that are above contract for different LTV categories. No evident relationship exists between LTV category and a willingness to yield or agree to a higher transaction price.
Appendix Table 7 presents the regression results for the downward renegotiation probability for this subset of borrowers. The impact of relevant explanatory variables is similar to those for the main estimation sample.
The 60% LTV is chosen because these borrowers have no additional Fannie Mae Loan-Level Pricing Adjustments for purchase mortgages. There is no additional charge for purchase borrowers with a FICO score of 660 or higher at this LTV value. 740, and up is obviously a subset of 660 and up and is chosen to obtain borrowers who are even less likely to face financing constraints.
We tested various definitions of “unconstrained”, with little difference in estimated effects.
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Acknowledgments
The authors would like to thank the journal editor and anonymous referees for their reviews. We thank Sumit Agarwal, Mike Eriksen, and Vincent Yao for feedback on earlier versions of the paper. We also thank Franklin Carroll, Steven Corbin, Casey Jones, and Foong-Yin Wong for research assistance and the experts in Fannie Mae’s Loan Quality Center who read and interpreted home purchase contracts.
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Fout, H., Mota, N. & Rosenblatt, E. When Appraisers Go Low, Contracts Go Lower: The Impact of Expert Opinions on Transaction Prices. J Real Estate Finan Econ 65, 451–491 (2022). https://doi.org/10.1007/s11146-020-09800-6
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DOI: https://doi.org/10.1007/s11146-020-09800-6