Chapter: A buyer in Delaware is obtaining a mortgage that is insured by the Federal Housing Administration (FHA). Which of the following is TRUE regarding the appraisal? (EN)

Chapter: A buyer in Delaware is obtaining a mortgage that is insured by the Federal Housing Administration (FHA). Which of the following is TRUE regarding the appraisal? (EN)

Understanding FHA Appraisals: A Scientific Perspective

FHA appraisals differ significantly from conventional appraisals due to the FHA’s mandate to protect both the borrower and the government. This protection is achieved through a rigorous appraisal process designed to ensure the property meets minimum safety, security, and soundness standards.

1. The Role of the FHA Appraiser: Independence and Qualification

• Independence: FHA appraisers must be independent and unbiased. They are selected from an FHA-approved roster and cannot have any familial or financial relationships with the buyer, seller, real estate agents, or lender involved in the transaction.
• Qualification: FHA appraisers must meet specific educational, training, and experience requirements established by the Department of Housing and Urban Development (HUD). They must also pass a national examination and maintain continuing education to stay current with FHA guidelines and appraisal best practices.
• Appraiser Independence Requirements (AIR): Regulations preventing undue influence on appraisers ensure unbiased valuation.

2. The Appraisal Process: A Detailed Inspection and Valuation

The FHA appraisal process comprises several key steps:

1. Physical Inspection: The appraiser conducts a thorough physical inspection of the property, both inside and out. This inspection focuses on identifying any safety hazards, structural deficiencies, or code violations that could affect the property’s habitability or value. The appraiser will document their findings with photographs.
2. Minimum Property Standards (MPS): The inspection strictly adheres to the FHA’s Minimum Property Standards (MPS). These standards cover areas such as:
   • Structural Integrity: The foundation, walls, roof, and other structural components must be sound and free from significant defects. Examples include examining for cracks in the foundation, leaning walls, or evidence of water damage.
   • Safety Hazards: The property must be free of safety hazards, such as lead-based paint (for properties built before 1978), asbestos, and radon.
   • Mechanical Systems: Heating, ventilation, and air conditioning (HVAC) systems, plumbing, and electrical systems must be in proper working order. The appraiser will verify functionality and adherence to local codes.
   • Utilities: The property must have access to adequate utilities, including water, sewer (or septic system), and electricity.
   • Accessibility: The property must be accessible and have safe access to and from the street.
3. Market Analysis: The appraiser conducts a market analysis to determine the property’s fair market value. This involves researching comparable sales (comps) of similar properties in the same area. These comparable sales are adjusted to account for differences between the subject property and the comps.
4. Valuation: The appraiser uses the sales comparison approach, cost approach (less commonly used for existing homes), and income approach (rarely used for single-family homes) to estimate the property’s value. The sales comparison approach is the most common method.

   • Sales Comparison Approach:

     • Formula: Estimated Value = Sales Price of Comp ± Adjustments
     • Example: If a comparable property sold for $300,000 and had a larger lot than the subject property, the appraiser would subtract an amount from the comp’s sales price to account for the difference in lot size.

3. Minimum Property Standards (MPS) and Defect Notification:

• Mandatory Repairs: If the appraiser identifies any deficiencies that violate the MPS, they will require these to be repaired before the FHA loan can be approved. Examples include:
  • Leaking roof
  • Faulty electrical wiring
  • Lead-based paint hazards
  • Evidence of termites or other wood-destroying insects
• Condition Issues vs. Cosmetic Issues: FHA appraisals focus on the condition of the property, not necessarily the cosmetics. While peeling paint inside is likely acceptable, peeling paint outside (especially on pre-1978 homes) can be a lead-based paint hazard and require remediation. Similarly, stains on ceilings indicating potential roof leaks are major concerns, while outdated décor is generally not.
• Reporting: The appraiser reports any issues directly to the lender, who then informs the buyer.

4. Appraisal Validity and Re-certification:

• Validity Period: FHA appraisals are typically valid for 120 days. This ensures that the market conditions used in the valuation remain relatively current.
• Extensions/Recertification: If the loan closing is delayed beyond the validity period, the appraiser may need to recertify the appraisal to ensure that the market conditions have not changed significantly. In some cases, a full reappraisal may be required.

5. Key Differences between FHA and Conventional Appraisals:

6. Hypothetical Experiment Illustrating MPS Impact:

Objective: To demonstrate the impact of MPS violations on an FHA appraisal valuation.

Methodology:

1. Two identical properties are chosen in the same neighborhood.
2. Property A is in excellent condition, meeting all MPS requirements.
3. Property B has a leaking roof and evidence of termite damage (MPS violations).
4. Both properties are appraised by FHA-approved appraisers.

Expected Result:

The appraisal for Property A will reflect its fair market value based on comparable sales. The appraisal for Property B will likely be significantly lower due to the cost of repairing the roof and termite damage. The appraiser will likely require these repairs to be completed before the loan can be approved. This demonstrates how FHA appraisals emphasize the condition of the property above market comparables when MPS violations exist.

7. FHA Appraisal Waivers

In certain limited circumstances, the FHA may waive the appraisal requirement. These waivers are usually based on automated valuation models (AVMs) and are only granted for low-risk refinance transactions. New purchases almost always require a full FHA appraisal.

8. Relevant Scientific Theories and Principles:

• Statistical Analysis: Used in market analysis to determine comparable sales and adjust for differences between properties.
• Engineering Principles: Applied to assess structural integrity and the functionality of mechanical systems.
• Environmental Science: Relevant to identifying and mitigating environmental hazards such as lead-based paint and radon.
• Risk Assessment: The underlying principle driving the FHA’s MPS and appraisal requirements, aimed at minimizing risk for both the borrower and the government.

In summary, an FHA appraisal is not solely about determining market value; it’s about ensuring the property meets specific safety and habitability standards to protect the borrower and the government. It’s a detailed, condition-focused assessment driven by rigorous guidelines and a commitment to minimizing risk.