Study Finds Banks Often Overvalue Homes in Foreclosure

Two Ohio economists with the Federal Reserve Bank of Cleveland found that banks consistently overvalue foreclosed homes, making it more difficult for Florida homeowners to obtain foreclosure loan modifications.

The economists looked at real-estate-owned (REO) properties, also known as foreclosures, and how they are handled by banks. They found that banks, property appraisers and investors consistently and systematically overestimate the values of properties in weak markets. When these properties are up for auction, the banks set their starting bids too high, lowering the chance that someone will purchase the home from the bank. When REOs are overvalued, lenders and homeowners in the neighborhood incur higher costs.

Valuations Made Without Seeing Interiors

Why banks overvalue these properties is not clear. Since current valuation methods work well in most markets, it may be that banks, federal agencies and investors have been slow to realize that these methods are not effective in weak markets.

The Ohio economists also propose that banks and appraisers may overvalue homes because they are seldom allowed into the REO home and must make their property value estimate on what they can assess from outside. If a home’s exterior is in good condition but its interior needs major repairs, the actual value of the home may be lower than perceived by appraisers.

In addition, overvaluing distressed homes at auction gives banks more control over the properties they buy, which may enable them to get a higher price for the home in the future. Holding onto REO properties is also beneficial for accounting practices, since banks can shift money from their loan portfolios to their REO portfolios, which are less likely to be used in solvency tests.

Fewer Loan Modifications When Homes Are Overvalued

Banks may also wish to overvalue the homes they foreclose upon to make it less likely homeowners will qualify for loan modifications. When a home is overvalued the homeowners are less likely to obtain a loan modification. If values were reduced, homeowners might be eligible for loan modifications.

The Federal Reserve economists recommend that banks adjust their valuation methods to place more value in the age and location of homes, which are better indicators of a home’s worth. More accurate prices would help reduce bank-initiated foreclosures and make loan modifications look like a better bet for banks.

Banks need to adjust their valuation methods so they estimate the actual value of a property, not its perceived value. Until these methods change, foreclosure rates will continue to be high and underwater homeowners will struggle to obtain loan modifications on their properties. Homeowners who are struggling to make payments on an overvalued property should contact an experienced Orlando bankruptcy attorney who can help defend against foreclosure.

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