Combating appraisal bias has been a priority of the Biden administration, which convened an interagency task force last year to address how appraisals contribute to disparities in housing.

On Wednesday, the Consumer Financial Protection Bureau took a step toward addressing the problem with a proposal that would require all banks and mortgage lenders to ensure automated appraisals are complying with nondiscrimination laws.

The CFPB’s 42-page plan kicked off an interagency rulemaking process that will lead to quality control standards for automated valuation models, or AVMs, which value a home using massive amounts of data from various sources.

Rohit Chopra, director of the Consumer Financial Protection Bureau, said that the bureau’s proposal for regulating automated appraisal systems “is one of many steps we are taking to ensure that … appraisals are fairer and more accurate.”

Bloomberg News

More than 40,000 small businesses — from small banks and credit unions to real estate companies, loan brokers and mortgage servicers — would have to comply with the upcoming rule, and could be impacted by the higher costs and regulatory scrutiny as a result.

CFPB Director Rohit Chopra, who is not a fan of using artificial intelligence and machine learning in underwriting, said that both in-person appraisals and AVMs can reflect bias.

“It is tempting to think that machines crunching numbers can take bias out of the equation, but they can’t,” Chopra said in a press release. “This initiative is one of many steps we are taking to ensure that in-person and algorithmic appraisals are fairer and more accurate.”

The AVM rule is one of the few outstanding rulemakings required by the Dodd-Frank Act. Dodd-Frank specified four factors for regulators to use as guideposts in crafting quality control standards for automated appraisals. AVMs must be designed to ensure a high level of confidence in the estimates, protect against the manipulation of data, avoid conflicts of interest, and require random sample testing and reviews.

In its proposal Wednesday, the CFPB said it is considering adding a fifth factor — namely, that AVMs be free of bias.

The CFPB specifically sought to include a requirement that “covered institutions establish policies, practices, procedures, and control systems to ensure that their AVMs comply with applicable nondiscrimination laws (we refer to this as a ‘fifth factor’).”

Some experts are concerned that regulators have limited resources to evaluate algorithmic computer models.

“More concerning is the CFPB does not have the technical resources to properly evaluate these models,” said Cliff Rossi, a finance professor at the University of Maryland’s Robert H. Smith School of Business and a former chief risk officer at Citigroup.

In the current sky-high housing market, lenders are turning to AVMs due to lower costs, shorter turnaround times and wider acceptance by Fannie Mae and Freddie Mac.

“Appraisals are dated, they are behind the times and the agencies are moving to a valuation market driven by data in their system, where they have repeat transactions, and they do not need an appraisal,” said Bill Dallas, president of Finance of America Mortgage, a Las Vegas-based mortgage broker and a industry veteran.

Since 2016, Fannie has provided relief from liability, also known as “Day 1 Certainty,” to lenders using its Collateral Underwriter automated appraisal tool, which has hastened the adoption of AVMs.

An AVM typically costs from $25 to $100, compared generally with $500 to $1,000 for an in-person appraisal. AVMs also are available immediately compared to an average two-week wait time for an appraisal, experts said

Appraisers are coming under scrutiny as well due to skyrocketing housing prices, up 20% last year and 10% in 2020, by some estimates, and ever-increasing bids for homes that some experts think is unsustainable.

“Everybody is overpaying for a home in America right now,” said Dallas. “There is no data to support the prices that homes are selling for.”

Home prices also skyrocketed in the run-up to the 2008 financial crisis when some appraisers were blamed for rubber-stamping the valuations sought by lenders, leading to more appraisal oversight.

Moving forward, the CFPB will convene a panel required by the Small Business Regulatory Enforcement Fairness Act and will publish a report on what the panel thinks of the proposal. The CFPB is required by Dodd-Frank to release an outline of any rule that potentially has a big impact on small businesses.

As to risks, the CFPB said it also is considering proposing specific requirements that “AVMs may be used incorrectly or inappropriately,” or “may suffer from fundamental errors and may produce inaccurate outputs.”

The CFPB, the Federal Trade Commission and state attorneys general have enforcement authority over nonbanks in the appraisal market. Prudential regulators will enforce the eventual rule for insurance banks, credit unions and financial institutions.

In the wake of the last financial crisis, Dodd-Frank directed the CFPB and five other agencies — the Federal Deposit Insurance Corp., Federal Reserve Board, Office of the Comptroller of the Currency, National Credit Union Administration and the Federal Housing Finance Agency — to create quality control standards for AVMs.

Experts say AVMs work well for homogeneous properties such as tract developments but may not be suited for rural areas, new construction, condos or unusual properties or tear-downs where the prior data is not reliable.

AVMs include “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.”

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