Lenders do not yet fully appreciate that an amendment to the Equal Credit Opportunity Act exposes them to unforeseen consequences.
What the amendment does is require a lender to furnish an applicant, upon request, a copy of the residential mortgage appraisal report.
Potential problems include:
* Disagreements over what exactly is required of a lender by the amendment.
* Charges of liability from third parties that suffer loss through unjustified reliance on the appraisal report's opinion of market value.
* Complaints from applicants unhappy with the report's opinion of market value.
Dangers of Misuse
The greatest risk to lenders is that an applicant will misuse the appraisal report's opinion of market value by showing the report to various third parties for purposes other than serving as an opinion of loan collateral value.
These third parties may rely on the appraisal report's opinion of market value, thus causing the third party to consider recovery from the lender for faulty appraisal procedures.
Lenders are well advised to devise strategies to contain the risk of applicant misuse and misunderstanding of a residential appraisal report.
One way is to educate potential borrowers about the appraisal process in order to dispel applicant misunderstanding. More importantly, lenders should seek to define and limit the institution's responsibility for the release, content, and use of the appraisal report.
Roots of the Amendment
To understand the risks and interpretation issues confronting lenders, it is beneficial to understand what prompted enactment of the law in the first place.
At hearings of the Senate banking subcommittee on consumer and regulatory affairs held in October 1989 and May 1990, witnesses testified that properties in certain neighborhoods were routinely undervalued by appraisers, which resulted in the denial or the discouragement of loan applications.
The Senate report explaining the provision suggested that by providing loan applicants with the right to obtain copies of appraisal reports, the applicants would be better able to determine whether a loan was denied due to a discriminatory appraisal.
Points Still Unclear
But the new appraisal availability requirement presents several unresolved interpretation issues.
The law states that applicants have the right to obtain a copy of the appraisal report on any application for a loan to be secured by a lien on residential real property.
The definition of "residential real property," and therefore the scope of appraisal availability, however, are not clear. Under a literal interpretation, the term "residential real property" could mean any real property on which a residence is or may be built, including home purchase loans, construction loans and home equity loans.
The statute specifies no standards as to what constitutes a "reasonable period of time" for an applicant to request a copy of the appraisal report. It is also an open issue concerning the time period appropriate for creditors to comply with the requirement to provide a copy of the appraisal report "promptly."
The appraisal availability statute contains no provision informing an applicant of the new right or how to exercise the right to obtain a copy of the appraisal report.
The Federal Reserve Board may issue proposed amendments at the end of the current federal moratorium on new regulations. The amendments would require creditors to provide applicants with written notice of the right to a copy of an appraisal report. The proposed amendments would also clarify the other interpretations issues.
A residential appraisal report is performed solely for the lender's benefit to estimate the market value of residential real property for loan collateral purposes.
Invitation to Misuse
Human nature being what it is, however, some applicants are certain to misuse the appraisal report. They may, for example, show the appraisal report to various third parties, such as the seller (perhaps on a false pretext so as to cancel a home purchase contract).
Other applicants will be unhappy with the report's opinion of market value or may nitpick aspects of the report. Dealing with such complaints will absorb precious employee staff time.
For these very reasons, most lenders, before enactment of the new appraisal law, refused to share appraisal reports with applicants.
To Head Off Problems
To deal with the risk of applicant misuse and misunderstanding of a residential appraisal report,k a lender may wish to considerk having an applicant sign an acknowledgment. Such a form would confirm delivery of the appraisal report and contain disclaimers limiting the institution's responsibility for the release, content, and use of the report.
The lender could, in addition to having the prospective borrower sign an acknowledgment form, also attach to each report a cover page that includes information and disclaimer language. Lenders should consider the following items for inclusion in an acknowledgment form and/or cover letter:
* A statement wherein the applicant acknowledges receipt of the appraisal report.
* A statement advising the applicant that the report was made solely for the lender's benefit to estimate the residential real property's value for loan collateral purposes and that neither the recipient nor any third person has any right to rely upon the lender's appraisal procedures.
* A statement that the market value reported as of a certain date may be affected by events subsequent to the report date and that neither lender nor appraiser has any duty to advise the recipient or any third party of changes in market value that may thereafter occur.
Agreement on Limitations
Alternatively, a lender could amend its application form (by rider or otherwise) to establish by contract that the loan applicant agrees to a limitation on use of the appraisal report, agrees to the absence of any duty to update the appraisal regarding changes in market value, and agrees that preparation of the appraisal report is solely for the lender's benefit.
With respect to the language that could appear on the cover of the appraisal report itself, topics which a lender might wish to address include the limitation on use, the absence of a duty to update the appraisal regarding changes in market value, and that preparation of the appraisal report is solely for lender's benefit to estimate the property's value for loan collateral purposes.
Exposure to Liability
The expected amendments coming from the Federal Reserve Board are supposed to clarify the unresolved interpretation issues. These amendments would be welcome.
But lenders should be far more sensitive to the risk that release of a residential appraisal report could expose a lender to allegations of liability regarding the appraisal report's opinion of market value.
Since appraisal availability is a relatively new development, lenders should seek competent legal counsel before implementing any procedure to limit the institution's liability for the release, content, and use of the report.