Michael Berman of Ncontracts: What Is Appraisal Bias and How Can My Mortgage Company Avoid It?

Michael Berman is founder and CEO of Ncontracts, Brentwood, Tenn., a provider of risk and compliance management platforms, and author of The Upside of Risk: Turning Complex Burdens into Strategic Advantages at Financial Institutions. His background in legal and regulatory matters has afforded him unique insights into solving operational risk management challenges and drives Ncontracts’ mission to efficiently and effectively manage operational risk. During his legal career, he was involved in numerous regulatory, compliance and contract management challenges and assisted in development of information systems to better manage these efforts. Prior to founding Ncontracts, he was General Counsel for Goldleaf Financial Solutions, Tecniflex Inc. and Imagic Corp.

Imagine an African American homeowner who wants to refinance the home she owns in an African American neighborhood. Her application is denied because of the low valuation of her home appraisal. She applies again with another lender. She doesn’t disclose her race or leave any evidence in her home (such as family pictures) that would lead the appraiser to make assumptions about her race. This time the appraiser gives her home a much higher value and she’s approved for refinancing.

Unfortunately, the anecdote above is not hypothetical. It’s a real complaint that a homeowner filed with HUD against Chase Bank, alleging Chase rejected her refinancing based on the discriminatory low appraisal of her home—a violation of the Fair Housing Act.

Appraisal bias, or when an appraiser considers illegal factors such as the race of the homeowner or the racial makeup of a neighborhood when determining the fair market value of a property, doesn’t sound like a problem that should occur in 2022, but it regularly does.

Just 7.4 percent of homes in predominantly white census tracts fail to appraise at their contract price compared to 15.4 percent in Latino tracts and 12.5 percent in black tracts, a Freddie Mac study found. One contributing factor is the demographic makeup of the appraisers. The Appraisal Institute reports that 85 percent of appraisers are white and 78 percent are male—a cross section that does not reflect the makeup of U.S. population.

Eliminating appraisal bias
As studies reveal the pervasiveness of appraisal bias, the regulatory agencies are seeking to increase diversity and inclusion in the appraiser population. The Biden Administration created the Interagency Task Force on Property Appraisal and Valuation Equity (PAVE) in June 2021 to address inequity and discrimination in home appraisal. Fannie Mae notes “it is unacceptable for an appraiser to develop a valuation conclusion ‘based either partially or completely on the sex, race, color, religion, handicap [disability], national origin, familial status, or other protected classes of either the prospective owners or occupants of the subject property or the present owners or occupants of the properties in the vicinity of the subject property.’”

Individual lenders are also expected to manage fair lending appraisal risk. Lenders can be held liable by consumers and regulatory agencies for providing consumers with appraisals that demonstrate inconsistencies, inaccuracies, and discriminatory biases.

How mortgage companies can avoid discriminatory appraisal practices
That’s exactly what happened to Chase. To resolve the complaint, Chase entered into a Conciliation Agreement with HUD that included detailed terms and monetary penalties. Such agreements—along with agency guidance, litigation outcomes, and enforcement actions—are a valuable source of tips and takeaways for identifying and decreasing appraisal bias.

Here are seven takeaways just from the Chase case.

1. Appraisers need fair lending training, including Reconsideration of Value. Home lending staff need mandatory training and a best practices document to serve as a quick reference guide—including how to conduct ROV processes step by step. It should also address:
   ▪ Specific inconsistencies, inaccuracies, and problematic terminology that lend themselves to fair lending violations
   ▪ How to identify and flag discriminatory terms
   ▪ Handling customers’ ROV requests and submissions in a timely fashion
   ▪ Ensuring there are at least three or more alternative comparable sales when conducting an appraisal
   Additional fair lending and appraisal bias training may also be necessary.
2. Appraisal complaints should be properly escalated.
   Lending staff should know to escalate customer complaints related to appraisal discrimination. Customers’ appraisal discrimination complaints are often not followed up on, investigated, or resolved as effectively, the FHFA found. Failure to train staff to identify, escalate, and manage complaints—especially when they pertain to appraisal bias—will inevitably lead to a greater risk of litigation andenforcement actions against an institution.
3. Revise appraisal transmittal letters.
   Consider adding language recommended by HUD in Chase’s Conciliation Agreement to the cover letter accompanying all appraisal reports to include: “We are committed to maintaining appraiser independence and preventing attempts to influence appraisers in the preparation of appraisal reports, as well as avoiding any discrimination or bias in the appraisal process. If you believe that any person has attempted to influence the appraiser in the preparation of the appraisal of your property, or have any concerns with the reliability or credibility of the appraisal, please contact us by calling _ as soon as possible to report any concerns of discrimination or bias or to discuss your options to contest the reliability of the appraisal.”
4. Revise adverse action notices.
   Consider asking customers to self-report bias issues by including HUD’s recommended language on adverse action notices sent to customers on loan application denials: “Please contact us by calling _ to report any concerns of improper influence, discrimination or bias during the process of this loan application.” An effective complaint management process will help ensure that customer feedback is properly addressed.
5. Enhance appraisal evaluation processes.
   When evaluating appraisals, make sure that they comply with all applicable laws including the Fair Housing Act, state and local antidiscrimination laws, and valuation and reporting protocol requirements. Automation within the property valuation process could also help remove appraisal bias from the process.
6. Appraisal quality control & monitoring.
   Establish or enhance reviews of appraisals with detailed quality control and monitoring procedures. For instance, consider conducting routine random and targeted quality control appraisal reviews, institute a process to identify appraisals and appraisers who present anomalies that could add to discriminatory valuations, and flag appraisals that utilize prohibited terminology and language that present or give the perception of bias.
   The FHA gives examples of problematic demographic phrases to look for when reviewing appraisals. Neighborhoods described as “desirable,” “crime-ridden,” “affordable,” or “integrated” are red flags. These seemingly innocuous phrases are all subjective terms that can denote discriminatory appraiser bias.
   FHA also provides objective descriptions that can be used in place of such demographic terms, such as listing neighborhood specific features (i.e., “newly updated neighborhood pool”), giving the specific statistics from objective, reliable sources (e.g., crime rate), aligning the appraisal valuation with comparable sales, and focusing on the property itself versus the homeowners and neighbors that surround the appraised property.
7. Conduct appraisal keyword searches for potential race-related red flags
   FHFA reviewed millions of appraisals and identified thousands of potential race-related red flags that should not be included in appraisals and/or flagged. These keywords and phrases include:
   ▪ The area’s racial and ethnic mix (e.g., describing an area as “‘not especially-diverse’ ethnically,
   with a high percentage of white people.”)
   ▪ Residents’ birthplace (i.e., foreign birthplace) included in the neighborhood descriptions
   ▪ Languages spoken in an area
   ▪ Amenities specifically geared to a race, ethnic, or religious group (e.g., a “commercial strip
   featuring storefronts supplying Jewish Households”)
   ▪ Attributing rising housing prices to gentrification
   ▪ Referring to a neighborhood as originally “White-Only,” before becoming a “White-Flight RedZone” and noting the neighborhood is now mostly “Working-Class Black”
   ▪ Describing as property’s location as a “homogenous neighborhood with good schools.”
   Lenders should consider conducting a similar keyword and phrase search and flagging these on their
   appraisals.
   
   Appraisal discrimination is of high importance to the Biden administration, the agencies, the news media and consumers. To avoid the risk of litigation, complaints, enforcement actions, and reputational risks, lenders should consider incorporating these best practices in their appraisal review, complaint, and training policies and procedures as part of their fair lending compliance management. Lenders should also be proactive by incorporating these best practices and encouraging second appraisals if initial appraisals present any evidence of possible bias.
   Don’t run the risk of appraisal bias. Make sure your mortgage company has strong controls to identify and eliminate appraisal bias.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)