So, you
thought properties were expensive where you live. Check out what $350,000 can
buy you in San Francisco: http://fusion.net/story/199332/this-is-what-a-350000-house-in-san-francisco-looks-like/
I’ve seen so
much of this recently, I felt compelled to write about it. I believe we could
save divorcing homeowners millions of dollars in unnecessary expenditures –
specifically appraisal costs. And, it’s so simple but the knowledge is not
widespread enough to actually make a dent in the following 3 costly mistakes divorcing
parties make.
When
negotiating the property settlement, the value of the house is sometimes a
matter of great consternation. Not only are parties and attorneys spending lots
of time around the table trying to agree on value and equity, but I have found
that they are paying money to arrive at a settlement which, many times, cannot
be financed and might be unworkable in the real world.
Here are the
top three mistakes I see related to establishing the home’s value and it’s
so-called “equity.”
1. Ordering
your own appraisal
How can I put
this diplomatically? Your appraisal doesn’t matter. Still not clear enough? How
about this – it’s totally useless. Well, maybe that’s not totally true in all
cases. But, when it comes to financing a buyout (Owelty agreement and lien) in
divorce, NO appraisal may be used in that lending decision other than the
appraisal which is ordered by the lender. In fact, the appraiser is not even
allowed to look at someone else’s appraisal. It’s called undue influence.
I am still
called on cases, to procure mortgage financing for divorcing parties, wherein
an appraisal has already been ordered – at a cost of several hundreds of
dollars, mind you. While I understand the need to establish value of the
parties’ property, the fact is if the grantee needs or wants to finance the
buyout, they will have to pay for another appraisal which the lender will
order. This, effectively, makes any other appraisal useless.
It’s actually
worse than that. One might tend to believe that an independently ordered
appraisal will, at the very least, give the parties/attorneys a ballpark figure
of value. After all, it will come from a licensed, professional appraiser. Right?
Here’s a little known fact: appraisals are assigned to a client. When the lender
orders the appraisal, the lender is the client. When an attorney or a divorcing
homeowner orders the appraisal, they are the client. The appraisals do not
transfer to another client. So, what does this mean? It means that the
appraiser knows whether or not an appraisal is going to be underwritten by a
professional underwriter who is accountable for a lending decision he/she
makes; or, simply reviewed by an amateur or attorney who is probably not well
versed in reviewing and critiquing appraisals.
I have seen
lender-ordered appraisals report a value 20+% lower than an independently
obtained appraisal. Let’s do the math on that.
Agreed value
(agreement based on an independently-obtained appraisal): $100,000
Mortgage Balance: $ 70,000
Agreed Equity
(another mistake which I shall correct in #3: $ 30,000
Agreed 50%
buyout/interest: $ 15,000
Now, let’s
say there are not even any closing costs in the borrower’s new loan (to include
the $15,000 buyout). Here is the new loan
First
mortgage $70,000
Owelty buyout $15,000
Need $85,000
Now, we get
the real appraisal which reports a value of $80,000, not $100,000. But, the
homeowner needs $85,000 or 106.25% of their home’s value.
Ain’t gonna
happen.
One more
thing. It’s tempting to rely on an independently-obtained appraisal if there is
no need for financing (buyout is not borrowed, paid out over time or the value
is simply entered in a column under assets to calculate the division/awarding
of total assets). You may think, what else can we do…there is no lending
process whereby we can obtain this much-vaunted, underwrite-able, useful
appraisal?
I suggest one
of two strategies at this point. First, if the client will apply to me for a
loan, I can order an appraisal through this lending process. Of course, I would
like to know – in advance – if there is no intention to follow through with the
financing. But, I can order the appraisal and deliver it to the client.
Secondly, if you order an appraisal directly, tell the appraiser something like
this: “I want this appraisal to be done as if an underwriter may review it for
a lending decision. I intend to have my mortgage professional, Noel Cookman,
and his staff review it for our case.” This will put them on notice that a
serious review will be conducted.
These two
strategies are still not as helpful as an actual lender-ordered appraisal that
is underwritten by the lender making an actual lending decision. One of the
reasons is that, underwriters have access to raw data and will be able to tell
if other properties are “leap-frogged” over in order to find comparables that
justify a higher or lower in value. I could write all day about this; but,
hopefully I’ve drawn a clear enough picture of the reality of the situation.
I realize
that there are multiple other factors the affect a person’s valuation of their
property. For example, a divorcing homeowner may truly and rationally be
willing to pay more for a property (technically a spouse’s interest in the
property) than what numbers on a piece of paper say it’s worth. But, that is an
intangible and non-quantifiable factor for which we can give very little
guidance. In other words, I don’t tell people how much they should pay in a
divorce buyout – my role is to try and make it work and inform them of limits
to financing.
2. Not
Receiving a Real Appraisal
…(preferring
instead a realtor’s opinion (CMA, Comparative Market Analysis) or the value
assigned to the property by the taxing authority (usually the county).
I don’t know
which is worse. Getting a bogus appraisal or relying on CMA’s and county
assessments. By the way, every county in Texas has its MIS-NAMED “appraisal
district.” And, folks refer to the county’s opinion of value as its “appraised
value.” After all, the government tells us that it’s an “appraisal” department
and the value is listed as an “appraised” value. The county does NOT appraise
ANY property – it assigns a taxable value and assesses taxes based on
that assignment. Citizens generally seem to assume that their property
“appraises” for a lower amount than that for which they purchased it more
recently. And, in many cases, that appears to be true. But, not in all cases
and – here’s the important part – no one knows what that differential is. So, there
is still no way of knowing the true market value of a property without a real
appraiser performing the real research in his/her report to a lender of an
“opinion of value.”
Speaking of
which, an appraisal is really an appraiser’s report of “opinion of value.”
That’s right – it boils down to an opinion. However, from which person or
entity are parties and attorneys most likely to receive a reliable, accurate,
market-based opinion?
- a realtor
preparing a Comparative Market Analysis based on price per square footage, etc.
- a
government agency whose bureaucrats work in an office and do not visit the
properties.
- a divorcing
client sitting at the table arguing a certain value based on his/her neighbor’s
alleged sale.
- a licensed,
certified appraiser vetted by various lenders and approved to work on a panel
in an Appraisal Management Company.
The point is,
only an appraisal, conducted by a trained/certified appraiser, can give you and
me the clearest look at a property’s market value.
3. Miscalculating
Equity
I suppose
it’s already implied that calculating “equity” on the wrong report of appraised
value is, in itself, a miscalculation. But, there is one more important step in
calculating equity – the consideration of two major factors especially when it
comes to a buyout.
The first
consideration is “transactional costs.” It’s important to distinguish between
closing costs and “transactional costs.” A seller, for example, will have some
closing costs (generally) but will have other “transactional costs,” both of
which diminish their net proceeds or what is improperly called “equity” in
their sold property. So long as we understand that “equity” is more of a fluid
number than most people think, you can generally think of equity as the value
of the property less the indebtedness (mortgage liability payoff, liens, taxes
and other encumbrances) against it less the transactional costs.
I thought
most people knew this. But, I’ve recently seen divorce settlements that
subtract the outstanding mortgage balance from the assumed value (and I DO
mean “assumed” because no appraisal had been secured on the property) and call
that the equity.
The second
consideration is “accessible equity.” This involves financing limits. Even
though there are many ways to determine actual loan limits, I speak generally
of the industry standard of “max LTV.” That is the Maximum Loan To Value ratio.
And that limit is 95%....approximately. FHA’s max LTV ratio is 96.500% in
purchases and 97.75% in refinances. VA does 100% financing but, it’s rare and
inapplicable enough for it not to be considered in this discussion. So, 95% is
a round figure and is the maximum financing generally available in
“conventional” mortgages.
But, here’s
the relevant application of these facts – it’s my statement to lawyers and
customers: Homeowners can never access the top 5% (or more) of their home’s
value – it gets eaten up in realtor fees (average of 6%) and other costs.
Therefore, I
use the 95% calculation. That is, the value of the property times 95% less the
indebtedness, less the transactional costs. If you use this formula, the
parties will get closer to an equitable division of “accessible” equity. Here’s
how it would work.
Assume the
property is worth $100,000 and the indebtedness is $55,000. If the parties are
seeking a 50/50 split, they might be tempted to calculate it like this:
$100,000 less
$55,000 (indebtedness) less $5,000 costs equals $40,000. Half of that is
$20,000. So, the grantee finances $55,000 mortgage payoff plus the $5,000
(costs) plus the $20,000 (buyout) for a total loan amount of $80,000 against a
$100,000 property. We’ve already learned that equity is not merely the
subtraction of the indebtedness from the value. So, we know that the new
equity is not $20,000. At the very least, the equity might be $100,000 less the
new loan of $80,000 less the finance costs of $5,000. That is, $15,000 which is
$5,000 less than what the grantor just paid their ex-spouse for their interest.
Not only that, but the principle of accessible equity means that the grantor
cannot access the top 5% of the property’s value and is capped (generally
speaking) at 95% LTV ratio or $95,000. So, the new “homeowner” now has only
$10,000 of accessible “equity” in the property or $100,000 X 95% = $95,000 less
the $80,000 mortgage less $5,000 finance costs.
Here’s how
the 95% calculation works for both parties to end up with something close to
equal “equity.”
$100,000 X
95% = $95,000
Less $55,000
(indebtedness), less $5,000 (costs) = $35,000. One half of that is $17,500.
Now, after
the grantee obtains financing and pays the ex-spouse $17,500, here is what the
new loan looks like:
$55,000
(first mortgage payoff) plus $5,000 costs plus $17,500 buyout = $77,500.
Now, how much
“accessible equity” has the grantee retained in the property? Let’s see. The
new loan is for $77,500 against a $100,000 property of which only 95% of its
value can be accessed for financing. So $100,000 X 95% = $95,000, less $77,500
(first mortgage payoff) equals $17,500 which is the same amount the grantee
just paid for their ex-spouse’s “equity” in the property.
Grant it,
this is an imperfect and imprecise way to calculate even the accessible but it
arrives at a figure much closer to real-world numbers than assuming that anyone
can access 100% of their property’s value.
Conclusion:
There is one
simple strategy you can use to save your clients money and establish a rational
value for a property. Have the client (who must finance a buyout) call me
SOONER THAN LATER.
It’s really
that simple. I will reinforce your bona fides in law and family law matters. I
will tell the client how wise you are and how you are saving them lots of money
by doing it right – that is, by following a protocol that will establish true,
professional, under-writeable, accountable values.
Noel Cookman
817-454-4555
noel@themortgageinstitute.com
