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.