Regardless of the size or nature of your financial institution, you must maintain documentation of an effective appraisal and evaluation program that demonstrates compliance and mitigates the inherent risk involved with real estate lending. An effective program will determine when an evaluation rather than an appraisal of the property will be sufficient in supporting a credit decision. Depending on the nature of the transaction and type of property involved, you may be able to rely on an evaluation rather than an appraisal.
Let's take a look at the common exemptions from the requirement to obtain an appraisal beginning with the appraisal thresholds.
In April 2018, the Agencies jointly published and amended the Real Estate Appraisals rule. Prior to the amendment, all real estate-related financial transactions, such as those secured by a single 1-4 family dwelling with a value less than the appraisal threshold of $250,000, did not require an appraisal. Likewise, qualifying business loans secured by real estate with a transaction value of $1 million or less do not require appraisals.
Qualifying business loans involve credit that is not dependent on the sale of the property for repayment or any rental income received from the property as the primary source of repayment. So, for the business purpose transactions that qualify, an evaluation can take the place of an appraisal.
While the new Real Estate Appraisals Rule did not remove those existing thresholds, the rule created a new definition of, and separate category for, CRE's or Commercial Real Estate transactions and raised the threshold for requiring an appraisal to $500,000 for those types of transactions.
A CRE transaction is a real estate-related financial transaction not secured by a single 1-4 family residential property. Therefore, the $500,000 threshold does not apply to transactions secured by a single 1-4 family residential property. For a transaction to be a CRE, the loan must be secured by multiple 1-4 family residential properties. For example, the definition of Commercial Real Estate transaction includes construction loans secured by multiple1-4 family residences.
Another common exemption from the appraisal requirements is the ability for an institution to take a lien on real estate in an abundance of caution. However, this exemption has limited application outside of the appraisal regulations, especially for loans secured by residential properties in which the real estate is the only form of collateral. In other words, securing a closed-end consumer purpose loan with real property in an abundance of caution may exclude you from the requirement to obtain an appraisal, but it does not exempt such loans from TRID disclosure requirements or RESPA.
For a business loan to qualify for the abundance of caution exemption, the Agencies expect the extension of credit to be well supported by the borrower's cash flow or other collateral. The credit analysis should verify and document the reliability of other repayment sources and determine that the market value of the property taken as an abundance of caution is ultimately unnecessary in making the credit decision. If other payment sources are absent or cannot be verified, this exemption should not be used merely to reduce the cost for the borrower or to minimize transaction processing time.
Under certain circumstances, renewals, refinancings and other subsequent transactions such as modifications or loan workouts may be supported by an evaluation rather than appraisal. The Agencies' appraisal regulations permit an evaluation for a renewal or refinancing of an existing extension of credit when either:
- No obvious and material change in market conditions or physical aspects of the property threaten the adequacy of the institution's real estate collateral protection after the transaction, even with the advancement of new money, or
- No advancement of new monies takes place, other than funds necessary to cover reasonable closing costs
An institution is considered to have advanced new money (excluding reasonable closing costs) when the principal amount of the loan over the amount of principal outstanding increases before the renewal or refinancing.
Keep in mind, even if a transaction qualifies for an exemption or falls under the threshold for requiring an appraisal, the Agencies still reserve the right to require an appraisal from a safety and soundness perspective depending on the nature of the transaction and the amount of risk involved.