Automated valuation models (AVMs) are one of the most popular modern valuation tools. An AVM is a computer algorithm that determines the value of a home without human assistance. Every AVM has its own method of calculating home values, but most use nearby real estate data — including recent sale prices, characteristics, and features of nearby properties — to generate an estimated value. Financial institutions use AVMs for lending decisions, marketing, underwriting, and more.
But what happens when an AVM won’t work for a lender’s needs? In this post, we’ll discuss the features of AVMs, appraisals, and when to use AVMs and appraisals for valuation.
When is it appropriate to use an AVM?
AVMs can be used for a range of loan types and situations:
- When combined with a property inspection, an AVM can be an effective valuation tool for home equity lending.
- An AVM can provide a quick and cost-effective way to value a pool of loans for portfolio valuation.
- In an appraisal waiver program when a loan isn’t risky enough to require a full appraisal, an AVM can be used.
- An AVM can serve as an effective quality control tool to verify a previous valuation.
- Get a quick pre-valuation “gut check” early in the customer funnel to make more reliable offers and decisions.
- And finally, an AVM can make collateral review and underwriting processes more efficient.
Lending-grade AVMs vs. marketing–grade AVMs
There are many AVMs in the market, each built upon a certain set of data and each with its own calculation method. This creates a lack of standardization and wildly varying levels of AVM quality. To simplify, we can categorize AVMs as either marketing-grade or lending-grade.
Marketing-grade AVMs are typically public-facing, designed to pique the interest of potential borrowers, and useful for sales lead generation, but potentially lack the quality data and model governance required for use cases that depend on accuracy. Lending-grade AVMs are typically used in decision-making, designed for situations that require highly precise results, and are compliant for use by financial institutions.
What’s the meaning of an AVM confidence score?
Lending-grade AVMs include a confidence score, which is typically based on the calculated forecast standard deviation (FSD) associated with the valuation. FSD is a statistical measure that represents the predicted error of the valuation and can be used to determine a highly probable value range for a property. The FSD can be used to understand the likelihood a valuation is accurate.
Clear Capital calculates FSD using an advanced secondary model that predicts the AVM’s accuracy specific to the individual property value, ensuring that users can make informed choices about the valuation based on its quality — not an AVM’s past performance of the given geography.
To better understand FSD and how it can be used to understand confidence, we can look at two examples:
- Both have AVM values at $100,000 but have different FSD
- A lower FSD means the probable range for the valuation is very tight
- A valuation with an FSD of 0.01 means the valuation is likely to fall within 1% of the AVM value
| Example 1 | FSD=0.01 | |
| Low Value as predicted by the FSD | AVM Value | High Value as predicted by the FSD |
| $99,000 | $100,000 | $101,000 |
Conversely, a higher FSD means the probable range of the valuation is wider. A valuation with an FSD of 0.5 means the valuation is most likely to fall within 50% of the AVM value.
| Example 2 | FSD=0.5 | |
| Low Value as predicted by the FSD | AVM Value | High Value as predicted by the FSD |
| $50,000 | $100,000 | $150,000 |
The Confidence Score posted with ClearAVM is the inverse of FSD (1-FSD) so, an FSD of 0.01 would represent 99% confidence, and a 0.5 FSD would represent 50% confidence.
AVM users will typically set a confidence threshold for each AVM they use. When underwriting a loan, a high confidence AVM may be required — but when providing an initial estimate, a lower confidence valuation may be useful.
What happens if you receive a low confidence score?
A lower confidence score occurs when there is a lack of similar properties, inconsistent sale prices for similar properties, or missing property information. If an AVM does not meet a lender’s quality threshold, they may seek alternative valuation methods, including property data collection or appraisals. Lenders may rely on a series of multiple AVMs from different providers, often called an AVM cascade or an AVM waterfall. If one AVM in the cascade fails to meet the confidence threshold, it will request another provider until an AVM with sufficient confidence is provided. This approach promotes independent, unbiased valuation results.
If a single AVM or an AVM cascade doesn’t support a lender’s needs, they can turn to an appraisal or alternate professional valuation, such as a broker price opinion.
What are the different types of appraisal?
When a lender needs an appraisal to accurately determine a property’s value, they’ll likely use one of the four most popular appraisal methods:
- Traditional appraisals fit a variety of lending needs, from conventional loans, refinances, home equity lending, and more. In a traditional appraisal, a licensed appraiser visits the property to conduct an interior and exterior inspection, measure gross living area (GLA), take photos, and observe value-influencing factors. The appraiser uses the information collected during this visit, as well as analysis of the local market to develop an opinion of value.
- Hybrid appraisals involve two parties — a property data collector who visits the property and collects information, and the appraiser who develops the opinion of value. Appraisers use additional data sources such as the local Multiple Listing Service (MLS) and tax information alongside the property data collection to determine a home’s value. Hybrid appraisals can be used for home purchase, refinance, and home equity loans.
- Desktop appraisals are similar to hybrid appraisals. When performing a desktop appraisal, the appraiser will rely on pre-existing information collected about the property, comparable properties, tax information, and more to determine an opinion of value without visiting the property. Desktop appraisals can be used for purchase loans.
- Inspection-based appraisal waivers are a recent addition to the GSE Selling Guides. Inspection-based appraisal waivers shorten the valuation process by allowing buyers to skip the appraisal. Instead of ordering an in-person appraisal, lenders can use an automated underwriting system to determine if the purchase price or the owner’s estimate of value is acceptable. Automated underwriting systems use comparable sales and past sales data from the home to determine if the home is accurately priced.
Should you use an AVM or an appraisal?
Now that you know the differences between AVMs and appraisals, which should you use? Well, that depends on a variety of factors — including loan type, the type of lending decision, your quality needs, and more.
AVMs are delivered faster, are more cost efficient, and are more readily available than appraisals. But even the best AVM can only provide an estimate of value based on the information available to it. AVMs struggle to make accurate predictions for properties with unique features or markets that lack consistency in sale prices for similar homes.
Appraisals are a reliable method for valuations, and many lending scenarios require an appraisal based on investor guidelines. Appraisals may take longer to complete, cost more, and require scheduling, but they provide a reliable opinion of value with the benefit of verification of the physical state of the property. That said, there’s value in using an AVM in tandem with an appraisal, whether during pre-valuation to provide transparency and set borrower expectations, or as a secondary valuation to support the appraised value.
Learn about Clear Capital’s national-coverage ClearAVM and our appraisal modernization solutions. Order ClearAVM in minutes on Clear Capital’s Product Portal. Email sales@clearcapital.com for more information.
