The Consumer Financial Protection Bureau [1] (CFPB) recently outlined options to ensure that computer models used to help determine home estimates are accurate and fair. The options will now be reviewed to determine their potential impact on small businesses.
When underwriting a mortgage, most lenders require an appraisal, which is the estimated value of the home. While traditional appraisals are conducted in-person, many lenders also employ algorithmic computer models. The technical term for these models is automated valuation models, and they use massive amounts of data drawn from many sources to value homes. The typical in-person and algorithmic appraisals may be susceptible to bias and inaccuracy, lacking the appropriate safeguards.
“It is tempting to think that machines crunching numbers can take bias out of the equation, but they can’t,” said CFPB Director Rohit Chopra. “This initiative is one of many steps we are taking to ensure that in-person and algorithmic appraisals are fairer and more accurate.”
Along with its federal partners, the CFPB intends to:
- Ensure a high level of confidence in the estimates produced by automated valuation models
- Protect against the manipulation of data
- Seek to avoid conflicts of interest
- Require random sample testing and reviews
- Account for any other such factor that the agencies determine to be appropriate
Obtaining an accurate estimate of a home’s worth is one of the most important steps in the mortgage process for homebuyers. Inaccurate valuations, both too high and too low, can pose risks to consumers. Given their crucial role, the Dodd-Frank Wall Street Reform and Consumer Protection Act tasked the CFPB and other regulators with implementing rules on these models.
Overvaluing homes can also put family wealth at-risk, create reselling challenges, and may lead to higher rates of foreclosure. Homes can be overvalued for numerous reasons, such as housing prices inflating, including lenders extending mortgage credit without regard to the borrowers’ ability to repay. In other situations, supply can become constricted and unable to keep pace with demand.
Low valuations can jeopardize home sales and prevent homeowners from refinancing, which makes it harder to accrue wealth or make repairs. Systematically low valuations driven by biased appraisers may worsen existing disparities within the housing market. The Federal Housing Finance Agency [2] recently identified discriminatory statements in some home appraisals, and both Fannie Mae [3] and Freddie Mac [4] have found appraisal disparities for communities and borrowers of color. Homeowners and homebuyers are often dependent on appraisers’ views of a community and of the people that live within it. When those views are negative, the undervaluing of homes can be the result.
Computer models and algorithms are additional tools for mortgage lenders and appraisers to improve valuation accuracy. However, automated valuation models can pose fair lending risks to homebuyers and homeowners. The CFPB is concerned that without proper safeguards, flawed versions of these models could digitally redline certain neighborhoods and further embed and maintain historical lending, wealth, and home value disparities. The CFPB’s wide range of options will aid in strengthening the oversight of these models.
Read the CFPB’s Outline, Small Business Advisory Review Panel for Automated Valuation Model (AVM) Rulemaking here [5].