How Much Is That Home Really Worth? Appraisal Bias and House-Price Uncertainty

Q1 2010

Business Review — With house prices often below the face value of mortgages these days, the expected return on many mortgages has tumbled, since one of the major forces supporting mortgages, the collateral, has weakened.

One source of these mortgage problems has been the validity of the home appraisal, which is supposed to be an objective and expert dollar valuation of the house that should help make a mortgage less risky. Unfortunately, the appraisal process can go awry and often has. As Leonard Nakamura shows in this article, appraisals have been biased upward, making mortgages riskier. Now a reverse risk is at work: The bias is going the other way, causing home valuations to be underestimated, possibly making new mortgages harder to obtain. In addition to problems of bias, Nakamura discusses the appraisal process, how it’s supposed to work, and how it can go awry.

This article appeared in the First Quarter 2010 edition of Business Review.

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