Fair lending issues continue to be at the top of regulators’ concerns in 2022, and one aspect being particularly scrutinized by various federal government agencies is appraisal bias. Another term for illegal discrimination within the property valuation process, appraisal bias occurs when an appraiser considers protected class factors such as the race or ethnicity of the homeowner or the racial or ethnic makeup of a neighborhood when determining the fair market value of a property.
But if the appraiser is the one acting in an illegally discriminatory manner, can it be a fair lending issue for the bank? The short answer is yes. Lenders of course must comply with the Equal Credit Opportunity Act (ECOA) and the CFPB’s implementing Regulation B, and the Fair Housing Act (FHA). Regulation B prohibits creditors from committing acts or practices directed at prospective applicants that could discourage a reasonable person, on a prohibited basis, from applying for credit, or in any aspect of a credit transaction. Among these aspects are a creditor’s “information requirements,” “investigation procedures” and “standards of creditworthiness,” all of which cover appraisals of collateral property. For example, if a bank, in denying an application, relied on an appraisal that undervalued a home because it was owned by a minority family, it may be liable under ECOA. This is true regardless of whether the appraiser is a staff appraiser (a bank employee), where it is easy to see how the bank could be held liable, but it is also true when the bank relies on an appraisal performed by a fee (or outside) appraiser, or from an appraiser engaged by an Appraisal Management Company, or AMC.
Prohibited bases may also not be considered in the appraisal process according to the Fair Housing Act. Section 3605(c) states, “Nothing in this subchapter prohibits a person engaged in the business of furnishing appraisals of real property to take into consideration factors other than race, color, religion, national origin, sex, handicap, or familial status.” The Department of Justice (DOJ) in early 2022 filed a statement of interest in connection with a lawsuit alleging defendants violated the FHA by discriminating on the basis of race in connection to a residential home appraisal. In their statement, the DOJ pointed to caselaw stating that, under the FHA, “proper defendants for appraisal-related discrimination may include not only appraisers, but their employers and the lenders who relied on their valuations.” Appraisal bias is therefore an issue that banks must clearly monitor due to potential legal risk.
The issue has garnered quite a bit of attention over the past year. On January 26, 2021, the White House issued a “Memorandum on Redressing Our Nation’s and the Federal Government’s History of Discriminatory Housing Practices and Policies.” The memo was directed to the Secretary of Housing and Urban Development (HUD), as HUD is the federal agency responsible for enforcing the FHA. The Secretary of HUD was directed to “take all steps necessary” to affirmatively further fair housing. The memo referred to, among other things, “a persistent undervaluation of properties owned by families of color” among the “legacies of residential segregation and discrimination [that] remain ever-present in our society.”
In June 2021, the Property Appraisal and Valuation Equity (PAVE) Interagency Task Force, an interagency group comprised of representatives of over a dozen federal agencies (including all the banking regulators), was formed to “address inequity in home appraisals.” Several meetings and “listening sessions” have been held soliciting feedback from various stakeholders in the residential mortgage lending industry. The task force will in 2022, issue a report that “proposes a set of policy recommendations and consumer-facing actions that participants can take to advance racial equity in the appraisal process.”
Studies and Reports
That appraisal bias is real and not speculative is substantiated by statistics and analysis. In January 2022, a report commissioned by the Appraisal Subcommittee (ASC), which is charged with oversight over the appraisal process for federally-related transactions, was issued with the findings from a study of appraisal standards. The report is “intended to represent a comprehensive and independent review of the appraisal standards and appraiser qualifications to ensure that neither encourage or systematize bias, and that both consistently support or promote fairness, equity, objectivity and diversity in both appraisals and the training and credentialing of appraisers.” The report was generally critical of the appraisal industry and made numerous recommendations, including increased training of appraisers to address bias and discrimination issues, and revising the Uniform Standards for Professional Appraisal Practice (USPAP) to clearly state discrimination in appraisals is prohibited. The report also addressed what it saw as barriers to entry to the appraisal profession, including addressing disparate impacts on potential appraisers of color, and called for additional data and study to help reform the appraisal industry. The banking regulatory agencies in response delivered a letter to the Appraisal Foundation (of which the ASC is part) demanding clearer anti-discrimination language in proposed revisions to appraisal industry standards, as USPAP is revised every other year.
In mid-2021, studies were undertaken by both Freddie Mac and Fannie Mae, and reports issued. The Freddie Mac report, “Racial and Ethnic Evaluation Gaps in Home Purchase Appraisals,” examined “whether minorities (specifically Blacks and Latinos) are more likely to receive an appraisal value that is lower than the contract price during purchase transactions.” They found “substantial appraisal valuation gaps for minority versus White tracts”; specifically, while 7.4% of homes in white neighborhoods were valued at less than the contract price, 9.4% of homes in Latino areas and 12.5% of homes in Black communities were valued at less than the contract price. While the report stated the analysis had not yet identified the full root cause of the gap and called for further study, it did identify potential solutions including “addressing consumer disclosure and reconsideration of value processes, and revising fair lending exam procedures and risk assessments.”
The Fannie Mae report, “Appraising the Appraisal: A closer look at divergent appraisal values for Black and white borrowers refinancing their home,” is part of the agency’s “multi-part research effort to better understand appraisal valuation differences across different demographic groups.” 1.8 million appraisals performed in connection with refinance applications from 2019 to 2020 were examined. Refinance applications were selected “because the appraiser in a refinance transaction typically interacts directly with the homeowner (i.e., the borrower), establishing a pathway for potential bias to influence the appraisal results,” and since the race and ethnicity of the borrower are disclosed in Home Mortgage Disclosure Act (HMDA) data, data correlations are possible. The report found that Black borrowers refinancing their homes received a slightly lower appraisal value relative to automated valuation models (AVMs) and that homes owned by White borrowers were more frequently overvalued than homes owned by Black borrowers.
Among Fannie Mae’s recommendations were to increase the use of alternative property valuation approaches that would reduce contact between appraiser and borrower, and to continue to modernize the appraisal process for home loans. It also pointed out the relative lack of diversity of appraisers, which was also detailed in a later Fannie Mae blog post that stated that 85% of appraisers are White and 78% are male (as of the end of 2018).
In December 2021 the Federal Housing Finance Authority (FHFA), Freddie Mac’s and Fannie Mae’s regulator, published a blog post stating that it had found examples of “overt references to race, ethnicity, and other prohibited bases under federal fair lending laws,” which they said indicate the “continued presence of valuation bias.” The FHFA mentions that even though appraisers attest on the Uniform Residential Appraisal Report that “race and the racial composition of the neighborhood are not appraisal factors,” they found thousands of references to race and ethnicity when searching free-form commentary sections in appraisal reports. While the FHFA stated that many were false positives, there were a number of troubling examples: “Our observation of appraisals suggests that racial and ethnic compositions of a neighborhood are still sometimes included in commentary, clearly indicating the writer thought it was important to establishing value.”
A CFPB blog post, written in response, stated it is “deeply troubled” by discriminatory statements the FHFA found, as well as the “appraisal disparities for communities and borrowers of color” identified in the Freddie Mac and Fannie Mae studies.
Note that this issue is not limited to human-prepared appraisals. The CFPB commented in February 2022 on regulatory efforts to formulate new AVM regulations that “automated valuation models can pose fair lending risks to homebuyers and homeowners. The CFPB is particularly concerned that without proper safeguards, flawed versions of these models could digitally redline certain neighborhoods.” It will be interesting to see what these safeguards against potential bias in automated models might be, but existing model validation standards and statistical testing methodologies might hold clues on what to expect.
What Can Banks Do?
So how can lenders protect themselves against appraisal bias and potential liability under ECOA and FHA? Here are few suggestions:
- Ensure the bank’s appraisal review processes are capable of identifying any hint of appraisal bias. This includes reading individual appraisal reports for problematic language or phrases. Fannie Mae, in a June 2021 newsletter, included tips to avoid real or perceived bias, and listed examples of problematic phrases such as “desirable neighborhood,” “crime-ridden area,” “affordable neighborhood,” or “integrated community.”
Other indicators of appraisal bias could include, for example, discussions of the neighborhood’s racial and/or ethnic mix, comments about residents’ birthplace in neighborhood descriptions (indicating national origin), references to a common language spoken in the area, mentions of area businesses and amenities geared toward specific groups, and/or attributing rising housing prices to gentrification.
- Perform appraisal-related statistical analysis on mortgage loan files. Among other things, look for differences in appraised values versus contract amounts. Utilize demographic data submitted in connection with HMDA-reportable applications to differentiate between races and ethnicities. Also differentiate by loan purpose (such as purchases and refinancings), as Freddie Mac and Fannie Mae did, to get a loose approximation of whether there was applicant-appraiser contact. These types of analyses can get very detailed, including analyzing specific appraisers’ performance in various geographic areas, for example.
- Ensure all staff appraisers have appropriate fair lending training, and include appraisal bias-specific issues and concerns. Also inquire of fee (outside) appraisers and AMCs as to their commitment and training around avoiding appraisal bias.
- Consider adding anti-bias language to all appraisal reports that are provided to applicants, and provide a means for applicants to contact the bank to report any concerns or complaints.
- Ensure the bank’s complaint management processes are set up to immediately escalate any appraisal discrimination or bias-related issue received in a complaint (and require any fee appraisers to report similar complaints they may receive to the bank).
- Examine Reconsideration of Value (ROV) requests. Look for mentions of possible appraisal bias as the reason for the request, and also look for whether the ROVs were accepted (or not) and in what areas, as well as differences from the original appraised value when an ROV is performed.
- Examine situations where both AVMs and human-performed appraisals were performed on the same property, and look for any differences in valuation. If any are identified, determine the reason for the difference as well as where the property is located.
There is much more to be written about this story. We’re at just the beginning, but it would be wise to incorporate controls into lending processes to identify and hopefully prevent appraisal bias from becoming a critical fair lending risk.
As Seen In: ABA Bank Compliance Magazine – May / June 2022 Issue