When a real estate-related financial transaction is first made, unless it meets one of the exemptions listed in 12 CFR 722.3(a) for credit unions, it requires either an appraisal or a written estimate of market value. An appraisal performed by a state-certified appraiser is required if the transaction value is $1,000,000 or more. A residential real estate transaction of $400,000 or more requires an appraisal from a state-certified appraiser if the transaction is complex, or from a state-licensed appraiser if the transaction is not complex. Complex refers to either atypical properties, market conditions or the form of ownership. Credit unions can assume appraisals of residential properties are not complex unless the credit union has readily available information that a given appraisal will be complex. Transactions that are below these thresholds require written estimates of market value, which is another name for an evaluation.
When you renew or refinance a loan does it need a new appraisal or evaluation?
How does your credit department and lending staff determine if a new appraisal or evaluation is required when an existing loan is renewed or refinanced at your financial institution? Are there policies and processes in place that guide the staff to make the right decision? If there is not a process, your institution may make the wrong decision and be criticized by loan review or the regulators.
To begin, let me state that there are clear instances where you can use an existing appraisal or evaluation to support a loan renewal. The process you take to determine if a new appraisal or evaluation is required should be outlined in your institution’s written appraisal policies. Many lenders would intuitively consider negative changes in market conditions, deterioration in the properties condition, and/or the passage of time as possible reasons to get a new appraisal, but is the criteria clearly outlined and is the conclusion you come to documented in the credit file?
The passage of time by itself is not a reason to obtain a new appraisal. The appraisal regulation does not state the useful life of an appraisal or evaluation. Setting a certain period of time, say every one or two years, as a standalone criteria is not appropriate, although the likelihood that market conditions have changed does increase with the passage of time. Even a recently obtained appraisal may no longer be valid. On that last point, I observed an institution needing to get updated appraisals on a quarterly basis. During the great recession, changing market conditions in some markets like Phoenix required lenders to obtain appraisals as often as quarterly. An institution I was examining in 2009 had a concentration in loans in the Phoenix market and in order to prepare accurate books and records (think ALLL), quarterly appraisals were absolutely necessary.
The interagency appraisal and evaluation guidelines list the following factors to consider in determining whether a new appraisal or evaluation is necessary.
Passage of time.
Volatility of the local market.
Changes in terms and availability of financing.
Natural disasters.
Limited or over supply of competing properties.
Improvements to the subject property or competing properties.
Lack of maintenance of the subject or competing properties.
Changes in underlying economic and market assumptions, such as capitalization rates and lease terms.
Changes in zoning, building materials, or technology.
Environmental contamination.
Let’s consider how to apply the need for a new appraisal or evaluation on a renewal transaction. After considering the factors detailed above, your lending institution determines there has been an obvious and material change in market conditions (or alternatively the proprieties condition has deteriorated). The loan does not include an advancement of any new monies (other than reasonable closing costs which are allowed). In this case, the existing appraisal or evaluation is no longer valid. As long as now new monies are advanced your financial institution would need to obtain a new evaluation or alternatively, they could also get an updated appraisal. However, if new money is advanced then the institution is required to obtain an appraisal.
Let’s consider another situation. After performing an assessment based on the factors above, you determine that there has not been a material change in market conditions or physical aspects of the property that would threaten the adequacy of the real estate collateral. Your institution is renewing the loan, and you are not advancing any new money. In this case you would need to support the transaction with an appropriate evaluation. There are some options here. If you can validate an existing evaluation or appraisal, you can use that, or you could obtain a new evaluation, but a new appraisal is not required.
There are other exemptions for not obtaining an appraisal or evaluation in the Interagency Appraisal Guidelines and the above examples assume none of those other exemptions apply. Regardless of the conclusion you come to, you should document in the credit file the facts and analysis used to support the decision to use an existing appraisal or evaluation for a subsequent transaction or obtain a new one.
Pactola offers lender education classes that cover all aspects of evaluations and appraisals. We would also welcome the opportunity to help you set up a sound appraisal and evaluation program or provide training to your credit staff.
Rod Werhan was a career National Bank Examiner with the Office of the Comptroller of the Currency who retired in February 2020 after more than 36 years of service. His credit experience includes examining commercial and retail lending in community, mid-size, and large institutions.