AVMs: What You Don’t Know

Ignorance is not bliss —especially when it comes to business and the bottom line. Yet day in and day out, lenders are operating in the dark and losing dollars in the process. I wrote in the past about the most common misconceptions about AVMs, also known as automated valuation models, the most commonly used collateral evaluation tools. AVM are being used over one billion times each month, and I estimate that hundreds of millions of those billions of AVMs are being used by lenders and servicers in the mortgage industry. But even considering these gargantuan proportions, most mortgage folks are surprisingly unaware of how big an impact AVMs can have on their bottom lines.

Now, I’m going to cover three of the most common ways AVMs are being used today. And for those of you concerned with your bottom lines, I’ll get into the concrete details about how lenders and servicers are saving — or wasting — thousands of dollars or more each month, simply by the way they approach AVM suitability.

Accuracy Matters

One of the biggest misconceptions about AVMs is that they are inaccurate. We revealed the fact that standard error rates of AVMs are actually lower than those of traditional appraisals. While my aim is not to rank one form of evaluation above another, it is to point out that AVMs can be quite reliable and highly appropriate for lower risk activities and transactions. I’d also like to remind you that there is no benefit to using an unreliable tool, not where data and decisions are concerned. Accuracy matters.

This is a key point. When financial decisions are being made based on a reported dollar value, businesses need to ensure that the evaluation tools being used are producing the most accurate value possible. While this may seem like common sense, this is not the general practice being exercised in the mortgage industry when it comes to AVMs. Hundreds of millions of times each year, lenders and servicers are running AVMs without much thought as to the accuracy of the reported figures, and this haphazard approach is likely costing them more than they imagine.

The following are three of the most common ways that AVMs are being used by lenders and servicers today:

1) Mortgage Pre-qualifications

A lot of smart lenders are using AVMs in the pre-qualification process. As they’re taking a quick, cursory look at borrowers, they’re also taking a quick review of a property, to see if a deal is worth pursuing. AVMs are well-suited for this review. It takes just minutes to run an AVM, and if the right one is used, the results can be surprisingly accurate. However, if the AVM is not accurate, lenders are likely wasting money and missing valuable opportunities.

If an AVM comes in significantly below the property’s actual current value, lenders are missing opportunities in loans that can’t be made. Let’s say your average gross profit per loan is $4,000; even one lost customer a month can amount to nearly $50,000 in missed opportunities per year. If, however, the value comes in too high, lenders can invest valuable man-hours taking a loan through the process until an appraisal reveals that the transaction won’t go. Even at a pay rate of $25 per hour, a processor spending a mere four hours on a loan that will never fund is costing the company $100 on lost labor.

This situation might be understandable if an AVM returns a value of $200,000 and an appraisal comes in at $194,000, and it’s just enough to kill the deal. In cases like these, hopefully the loan officer informs the borrower that the value is tight and may not come in as needed. If, on the other hand, the appraised value comes in at $186,000, and there was clearly no reason to even run a full appraisal, chances are, you’re going to have a very upset borrower on your hands. Incidentally, in case you’re wondering, yes, there is a way to make sure that you have significantly fewer of those $200,000/$186,000 scenarios. That is absolutely within a lender’s control. I’ll get to the details of how later.

The Cost of Losing Trust

Back to the $200,000/$186,00 situation. There’s a more significant, long-term financial issue at hand here. Borrowers traditionally cover the cost of the appraisal, which is roughly $350 for the average non-FHA loan. From what I hear, borrowers don’t take very kindly to paying fees for a loan that has no possibility of being funded. While this is important for any lender to remember, credit unions, being the member-driven organizations that they are, might want to be particularly attuned to this.

There have been numerous studies of the costs of losing trust, and consequently losing a customer who feels he or she has been wronged.  Anecdotal evidence shows that a disgruntled customer will tell between eight and 16 people, with 10 percent telling more than 20. When you factor in the ease of communication and the viral nature of social media, the number increases exponentially. Even if they tell no one, 9 out of 10 unhappy customers will never purchase goods and services from you again. Not a good consequence when, according to Gartner Research, the cost of acquiring a customer is five times the rate of retaining existing ones.

I’ll leave it at that this month. Next month I tell you how else AVMs are commonly used and how they can improve your bottom line.

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