Alston & Bird Consumer Finance Blog

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CFPB and Other Federal Agencies Finally Adopt AVM Rule

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What Happened?

On June 20, 2024, a group of federal regulators published a rule addressing for the use of automated valuation models (AVMs) in mortgage origination and secondary market transactions.

The rule adoption – by the Consumer Financial Protection Bureau, Office of Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), and Federal Housing Finance Agency (collectively, the Agencies) – comes more than 13 years after the enactment of the Dodd-Frank Act.  Section 1473 of the Dodd-Frank Act mandated the promulgation of a rule to implement quality control standards for the use of automated valuation models by mortgage originators and secondary market issuers in valuing the collateral worth of a mortgage secured by a consumer’s principal dwelling – even one made for business, commercial, agricultural, or organizational purposes.  The rule will take effect October 1, 2025 (the first day of a calendar quarter following the 12 months after publication in the Federal Register).

Section 1473(q) of the Dodd-Frank Act amended the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), addressing the use of AVMs to estimate the collateral value of a mortgage for mortgage lending purposes in new section 12 U.S.C. § 3354.  The statute sets forth the framework for developing quality control standards to which AVMs must adhere and directs the Agencies to promulgate regulations implementing the standards.

What AVMs does the Rule Cover?

An AVM is any computerized model used by mortgage originators and secondary market issuers to determine the value of a consumer’s principal dwelling collateralizing a mortgage.  The rule’s quality control standards apply only to AVMs used in connection with making credit decisions or covered securitization determinations regarding a mortgage.  For example, the standards apply when determining a new value before originating, modifying terminating a mortgage, or making other changes to a mortgage including a decision whether to extend new or additional credit or change the credit limit on a home equity line of credit (including reductions or suspensions), or placing a loan in a securitization pool.  The rule treats assumptions as credit events.  By contrast, the rule does not cover other uses such as monitoring collateral in mortgage-backed securitizations after they have already been issued or validating an already completed valuation.

Why Is It Important?

The rule requires institutions that engage in covered credit decisions or securitization determinations – whether themselves, or through or in cooperation with a third party affiliate – to adopt policies, practices, procedures and control systems to ensure that the use of AVMs adheres to quality control standards.

“Control systems” are the functions (such as internal or external audits, risk review, quality control and quality assurance) and information systems that are used to measure performance, make decisions about risk, and assess the effectiveness of processes and personnel, including with respect to compliance with statutes and regulators.

In keeping with FIRREA, the rule’s quality control standards are designed to:

  • Ensure a high level of confidence in the estimates produced by the AVMs;
  • Protect against the manipulation of data;
  • Seek to avoid conflicts of interest;
  • Require random sample testing and reviews; and
  • Comply with applicable nondiscrimination laws.

In the rule, the Agencies take the standards one step further than the Dodd-Frank Act mandate, by requiring AVM quality control standards to comply with applicable nondiscrimination laws.  Exercising their statutory authority to account for other appropriate quality control factors, the Agencies’ inclusion of this fifth factor addresses concerns about the potential for AVMs to produce property estimates that reflect discriminatory bias.  In doing so, the Agencies have acted consistent with the Biden administration’s focus on appraisal bias, as exhibited in the PAVE initiative.

In adopting the rule, the Agencies remind institutions that the Equal Credit Opportunity Act and Regulation B, as well as the Fair Housing Act, apply to appraisals and AVMS.  Further, “institutions have a preexisting obligation to comply with all Federal laws including Federal nondiscrimination laws.” To that end, this fifth factor creates an independent obligation for institutions to establish policies, procedures, and control systems to ensure compliance with nondiscrimination laws.

The rule does not include specific requirements on how institutions are to structure their policies and procedures.  The Agencies intend this nonprescriptive approach to provide institutions the flexibility to set quality controls for AVMs as appropriate, based on the size of the institution and the risk and complexity of the transactions for which AVMs will be used.

Rule Applicability

Key to understanding the rule’s impact is an evaluation of what persons and loans are within its scope.

  • Mortgage Originators, Brokers, and Servicers: For purposes of the rule, the term “mortgage originator” has the same definition as under the Truth in Lending Act: any person who, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain, takes a mortgage application, assists a consumer in obtaining or applying to obtain a mortgage, or offers or negotiates terms of a mortgage secured by a consumer’s principal dwelling, even if the mortgage is primarily for business, commercial agricultural or organizational purposes.  That definition includes a mortgage broker; however, the rule does not apply to mortgage brokers if they do not engage in making covered credit decisions or securitization determinations.  The rule generally does not cover mortgage servicers, unless they are engaged in covered origination activity (for example, in connection with an assumption or a refinancing).  A mortgage originator does not include an individual who engages in “modifying, replacing and subordinating principal or existing mortgages where borrowers are behind in their payments, in default or have a reasonable likelihood of being in default of falling behind.”
  • Secondary Market Issuers: The rule applies to secondary market participants, including the GSEs or “any other party that creates, structures or organizes a mortgage-backed securities transaction,” which includes coverage of entities that are responsible for determining the collateral worth of a mortgage when issuing mortgage-backed securities. This encompasses secondary market participants in the securitization process that make these types of determinations, as opposed to verifying or monitoring such determinations.
  • Loan Applicability: The rule applies when a mortgage is secured by a consumer’s principal dwelling even if the mortgage is primarily for business, agricultural, or organizational purposes.  For purposes of the rule, a “dwelling” means a residential structure that contains one to four units, regardless of whether the structure is attached to real property.
Use of AVMs by Appraisers Not Subject to the Rule

The rule excludes from its scope a certified or licensed appraiser using AVMs in the development of an appraisal.  In creating this exclusion, the Agencies recognize that to comply with the Uniform Standards of Professional Appraisal Practice, appraisers must make valuation conclusions that are supportable independently and do not rely on the results produced by AVMs. Moreover, the rule excludes reviews of completed determinations from the scope of the rule: “if an AVM is being used solely to review the completed determination, the AVM is not covered by the [r]ule regardless of when the AVM is used after that determination.”

Additionally, the Agencies’ existing guidance regarding AVMs remains applicable separately from the rule.  For example, the OCC, Board, FDIC, and NCUA have issued guidance about prudent appraisal and evaluation programs in Appendix B to the Interagency Appraisal and Evaluation Guidelines.

What To Do Now?

Largely as proposed, the rule requires regulated mortgage originators and secondary market issuers to take appropriate steps and adopt policies, practices, procedures, and control systems to ensure that the use of AVMs in valuing real estate collateral securing mortgage loans adhere to the specified quality control standards, including compliance with nondiscrimination laws to avoid potential valuation bias. The rule requires institutions to create their own policies and procedures to ensure the credibility and integrity of valuation determinations produced by AVMs.

While AVM developers and vendors are not covered by the rule, covered institutions will need to work with their AVM developers and vendors to ensure compliance with its obligations.  It is likely that third party AVM testing entities will emerge to assist with these obligations. Vendor management oversight will be important.  Institutions will need to start thinking through their existing policies, practices,  procedures, and control systems now to identify what changes are necessary to ensure compliance on or before the rule’s effective date.

HUD Issues Guidance on Appraisal Reviews and Reconsiderations of Value

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What Happened?

Continuing its focus on appraisal bias, the U.S. Department of Housing and Urban Development (“HUD”) issued new guidance to Federal Housing Administration (“FHA”) mortgagees regarding appraisal reviews and reconsiderations of value (“ROVs”).  On May 1, HUD issued Mortgagee Letter 2024-07 (the “Letter”), announcing updates to the FHA Single Family Housing Policy Handbook (Handbook 4000.1), finalizing a proposal that outlines when a borrower may request an ROV and how the lender must respond.  The Mortgagee Letter includes substantially identical provisions applicable to FHA-insured forward and HECM (reverse) mortgage loans.

Why Is It Important?

Combatting appraisal bias has been a federal government priority since the 2021 announcement of the Interagency Task Force on Property Appraisal and Valuation Equity (“PAVE”).  As part of the PAVE efforts (as we previously reported), HUD published a draft version of the Letter (Borrower Request for Review of Appraisal Results) for public comment.  In the proposal, HUD sought comment on (among other issues) when material deficiencies in the appraisal process may merit a second appraisal and/or permit a borrower to request an ROV.  The Mortgagee Letter finalizes that proposed guidance, incorporating feedback received.

First, HUD has amended the criteria for determining whether a deficiency in an appraisal is “material.” In addition to having “a direct impact on value and marketability,” a material deficiency may be one that “indicates a potential violation of fair housing laws or professional standards related to nondiscrimination” (such as the USPAP Ethics Rule).  As an example of such deficiency, the amended Handbook will include “statements related to characteristics of a protected class,” unless the consideration is permitted by fair housing laws.

Second, HUD has clarified that when the nature of a material deficiency is such that the appraiser cannot resolve it, the underwriter may forgo communication with the appraiser before ordering a second appraisal.  If a mortgagee orders a second appraisal because of material deficiencies, it must report the deficient appraisal to the relevant state regulator (the appraisal board or equivalent).

Third, HUD has updated its requirements for appraisal review as they relate to the criteria for determining the acceptability of a property.  As in its proposed version, the Letter requires a mortgagee to ensure that its underwriters “review the appraisal and determine that it is complete, accurate, and provides a credible analysis of the marketability and value of the Property.”  The mortgagee must also ensure that as part of such review, the underwriter is able to identify appraisal deficiencies, including discriminatory practices.  The underwriter must remediate such deficiencies by: (a) requesting that the appraiser provide a correction, explanation, or substantiation (as appropriate); (b) requesting an ROV; and/or (c) ordering a second appraisal.

Fourth, HUD has added ROV requirements to its general property acceptability criteria.  When communicating with an appraiser regarding an ROV, the Letter requires the underwriter to: (a) include a description of the areas in the appraisal report and the additional information that require a response from the appraiser; (b) provide, as available, detailed information, data, or relevant comparables; (c) only include comparables that are relevant as of the appraisal’s effective date; and (d) include a maximum of five alternate comparables.  The appraiser must include his or her response in a revised version of the appraisal, and the mortgagee may not charge the borrower for costs associated with the ROV process.

Further, the Letter requires each mortgagee to establish a process for a borrower-initiated ROV request (which an underwriter must assess for applicability, and relevance and appropriateness of information, before communicating to the appraiser).  The Letter requires a mortgagee’s process for borrower-initiated ROVs to include: (a) the provision of a disclosure regarding the process, both at application and upon delivery of the appraisal report to the borrower; (b) specification in such disclosure of the process for submitting an ROV request, including any requirements for or limitations on supporting information; and (c) the establishment of protocols for communication with the borrower regarding the request throughout the ROV process.

Finally, the Letter requires a mortgagee to include in its Quality Control Plan standards for both the appraisal review and the ROV process.

What Do I Need to Do?

Mortgagees of FHA-insured loans have until September 2 to implement the Letter’s requirements (for FHA case numbers assigned on or after that date). However, given that early adoption is permitted, lenders should review the new requirements against their current practices to ensure these requirements are appropriately incorporated into a mortgagee’s policies and procedures and its vendor management oversight program (to the extent the mortgagee utilizes appraisal management companies).

PAVE Task Force Issues Action Plan to Address Appraisal Bias

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A&B Abstract: As part of the Biden Administration’s stated focus on narrowing the racial gap in wealth and homeownership, federal agencies launched an Interagency Task Force on Property Appraisal and Valuation Equity (PAVE), with the goal of “addressing the persistent misvaluation and undervaluation of properties experienced by families and communities of color.” On March 23, 2022, the PAVE Task Force released its Action Plan, which contains 21 specific actions to be taken by the 13 member agencies and offices of the Task Force and, in certain cases, Government-Sponsored Enterprises (GSEs), as well as general recommendations for the appraisal industry.

Components of the PAVE Action Plan: The Action Plan delineates 21 specific actions for the appraisal industry, with the goal of:

  • Increasing accountability and oversight of the appraisal industry, primarily by encouraging federal agencies to update their appraisal-specific policies and guidelines, expand regulatory agency examinations of mortgage lenders, and enhance interagency coordination and collaboration.
  • Ensuring that consumers are fully informed regarding the steps they can take after receiving a property valuation that is lower than expected, including the reconsideration of value process.
  • Preventing algorithmic bias by incorporating a “nondiscrimination quality control standard” into proposed federal rulemaking for automated valuation models (AVMs).
  • Promoting diversity in the appraiser profession by “remov[ing] unnecessary educational and experience requirements that make it difficult for underrepresented groups to access the profession,” as well as by bolstering fair lending training of existing appraisers.
  • Developing an aggregated database of federal appraisal data to better study, understand, and address appraisal bias, “complemented by a working group of subject matter experts from stakeholder agencies.”

Scope of the Action Plan: It is worth noting that, apart from these recommendations and the overall push toward federal rulemaking regarding appraisals, the PAVE Action Plan does not itself propose any substantive changes to the existing appraisal process. Unlike recent suggestions by various advocacy groups and public policy organizations, the PAVE Action Plan does not recommend specific revisions to the Uniform Standards of Professional Appraisal Practice (USPAP), such as identifying the homeowner or mortgage loan borrower as the intended user of the appraisal report. Rather, the Action Plan focuses on the existence of appraisal bias in home purchase appraisals (while acknowledging that refinances have not been studied as extensively) and suggests that more work is needed to evaluate alternatives to traditional appraisals, the use of range-of-value estimates in lieu of point estimates, and potential modifications to the sales comparison approach to appraisals. Notably, the Action Plan also acknowledges the federal government’s historical role in increasing valuation bias through the implementation of the Home Owners Loan Corporation.

Federal agency reaction: In response to the Action Plan, certain member agencies have publicly pledged their commitment to eradicating appraisal bias. For one, the Consumer Financial Protection Bureau (CFPB) has announced that it will be “closely scrutinizing the work of The Appraisal Foundation,” “working to implement a dormant authority in federal law to ensure that algorithmic valuations are fair and accurate,” and “developing a proposed rule.” The Federal Housing Finance Agency added that it will be “working with HUD and other interagency partners to share information and resources that strengthen fair lending oversight of the mortgage finance system.”

Takeaways: The various components of the Action Plan demonstrate that collaboration between lenders, federal agencies, advocacy groups, and industry associations will be necessary to craft a successful approach toward eliminating potential appraisal bias. For a more detailed discussion of the lender’s role and limitations in the existing appraisal process, please see Appraisal Values and Lender Liability: Art, Science, or Gamble?