I recently wrote a blog called Disclosure, Disclosure, Disclosure about the right way to flip a short sale deal. However very recently there has been alot of talk about short sale fraud even by the FBI. I recently recieved a email with the title “short sale fraud plagues the housing market”. Even though I wrote an article on this subject before, after reading the article I recieved, I felt compelled to respond and update this controversial subject.
In the article the author, when talking about how the short sale fraud occurs states “the scam artists usually real estate agents will secure a legitamite bid on a home one where the borrower owes far more on the mortgage then the home is worth. Then they arrange for a accomplice investor to make a lower offer on the home. The agent then presents the lower bid to the lender and asks them to forgive any remaining balance owed without disclosing that there was a higher bid made on the home. Once the short sale is approved the scammer then sells the home to the highest bidder often on the same day.”
Was this fraud? Absolutely. The real estate defendant used deception and his role as a real estate agent to lie about what offers were placed on the short sale. This was not a legitimate lawful flip of a short sale, this was a scheme by a greedy real estate agent to create fake offers and withhold a legitimate offer that was made on the subject property, with a buyer lined up to complete the fraudulent scheme. In the article the author talks about scams involving real estate agents who use a investor as a ‘straw buyer” where the buyer makes a fake offer for someone else in a scheme, where the buyer has no real intention to buy the property. This talk about a “straw buyer” has nothing at all to do with a legitimate short sale flip. The meathods used by the agent in the above example is deceptive, unlawful, dishonest, and unethical. However to imply that this particular case represents the way all short sale flips take place is ridiculous.
In doing a legitimate short sale flip all parties in the transaction are notified and understand exactly how the transaction will occur. There will be nothing to hide and as the agent you will submit every offer that comes in on the subject property. You will not be utilizing fake investor offers or any other fraudulent practices in the transaction.
As I wrote in my previous article on this subject, when all parties to the transaction are all fully disclosed and every party understands what is occuring at every phase of the transaction, then there is nothing illegal at all about doing short sale flips or double closings. However with the level of distrust on these type of transactions today, it is essential to make everthing clear in your contracts and paperwork.
Language that should be used in your contracts is as follows “seller understands that this this transaction is a short sale and is contingent upon acceptance of a short payoff to current lienholders acceptable to the buyer and is contingent upon the relisting of the property with a realtor to find a third part buyer to purchase, fund, and successfully close on this transaction. The seller will recieve no funds from either closing.”
This verbiage is clearly disclosing to the mortgage companies that you intend to buy the property with the intent to immediately resell it for a profit on the same day. There is absolutely nothing unlawful about doing this. In fact it is a win-win-win-win proposition. The seller avoids foreclosure, the lender gets a non performing loan off their books, the agent gets a commission, and the buyer gets a good deal.
In conclusion, the article that I am writing in response to is ignorant in that it groups all short sale transactions as fraudulent transactions. The buying and selling of cars, the buying and selling of gold, and the buying and selling of houses are all perfect examples of capitalism at its finest, as long as they are done legally and correctly. As long as there is full and complete disclosure among all of the parties in a short sale flip transaction, and it is all covered in all of the paperwork, there is absolutely nothing wrong with flipping short sale properties.
Major lenders are figuring out that short sales are actually a beneficial option when it comes to mitigating their losses and avoiding the lenthy and expensive costs that a lender incurs when it goes through the foreclosure process. Banks are inundated with REO’S. The amount of inventory lenders are currently sitting on is absolutely staggering. Banks have figured out that short sales in most cases, usually costs less than holding and trying to sell their foreclosed properties.
Recently many agents have been getting more of their short sale listings approved. Lenders are becoming more willing to work with realtors and are aggresively campaigning to encourage homeowners to do a short sale if they cannot get a loan modification. For example JP Morgan Chase is offering a range of incentives to borrowers that agree to a preforeclosure sale “because if we cant work out a modification, a short sale is is a better result for the borrower, the servicer, the investor, and the neighborhood than a foreclosure,” the company stated in a recent statement.
To show their commitment to encourage short sales many lenders are actually paying distressed sellers large incentives to complete a short sale. The amount the lenders are offering are significant to say the least. Chase is offering up seller incentives up to $30,000. An agent in Florida said that he recieved a letter from Chase offering $20,000 to a borrower he was representing in a short sale transaction. Another agent in California says he closed a short sale where the borrower was paid$ $ 30,000 at closing.
Wells fargo says it has been making”enhanced financial relocation assistance offers that can vary from $10,000, to $ 20,000 to certain borrowers who choose to do a short sale. Citi Mortgage has confirmed that it’s average incentive offer is currently $ 12,000. Citi states”incentives are offered to customers experiencing financial hardship who need funds to proceed with the short sale” a spokesman for the lender explained.
This is big news for agents who have had so many problems dealing with the lenders and getting their short sale deals to the closing table. Many of the procedures for realtors has been streamlined to make the process much easier. Bank of America says it is “committed to improving the short sale process and has made procedural changes to cut short the red tape for agents working with the bank on foreclosure sales.”
For agents the lender now allows real estate agents to submit a new offer on a transaction if the original buyer walked away from the transaction. This means that that agents do not have to initiate a new sale if the buyer changes” Bank of America explained. This is a major change with Bank of America and it’s annoying and confusing equator system. This change which will allow many more short sales to successively close.
These seller incentives will reduce the lender’s losses, provide homeowners with monetary encouragement to do a short sale and avoid foreclosure, give the buyer to get a good deal, and give the agents motivation to take on more short sale listings thus increasing their earnings. In a successful short sale transaction everybody wins.
If you do enough short sale deals at some point a buyer is going to drop out of one of your short sale listings. The main reason a buyer would walk away is that they feel the short sale is taking too long. One of the most dificult aspects of a short sale transaction is to get the lender approval before the buyer decides to drop out of the deal.
Whether you are the buyer broker or you represent the seller it is absolutely essential to set the expectations of the buyer. If you want the short sale to close, you must explain to the buyer that short sales can take 3 to 6 months to close if not more. If the potential buyer is not comfortable with that timeline then you do not have a real buyer. Short sales are usually good deals for buyers but they must understand that the trade off is that they may have to wait a little longer than they would then if it were a general transaction. In fact, I would argue that if the agent does not explain to the buyer what to expect during the short sale process then that agent has broken their fiduciary duty to their buyer in a short sale transaction.
You as the agent should accept offers only from potential buyers who will commit to the deal. In the contract/offer there should be language that addresses the buyer’s committment to the short sale. For example a clause might say that “earnest money is due upon seller acceptance and if the buyer walks away from the deal they will lose their earnest money deposit.” The buyer should be required to put down at least 10% on the deal. Without these protections and clauses the buyer can walk away at any time and suffer no consequences against him at all.
Language in the contract should also deal with issues such as inspections, buyer financing, title search etc. it should say something like”" all inspections, buyer financing etc. should begin once the seller accepts the offer”. By forcing the buyer to do all inspections and financing efforts as early on in the process as possible, this will signficantly increase the odds that the short sale deal will close and with less headaches. Many buyers wait until the lender gives their approval to start their financing process. This is a big mistake. Not having the buyer financing set up in time of the closing, or waiting to do the inspections too late in the process are both common deal breakers.
As the seller’s agent you can protect against buyers walking away from the short sale by procuring back up offers. There is nothing wrong with holding a couple of back up offers, in case the original buyer walks away fom the transaction.
Something you need to do is qualify potential buyers. You must ask questions such as Is your buyer prequalified for a loan? Are they willing to put down at least 10% ? When does the buyer need the deal to close? If you know that a buyer needs to get into the house by a specific date, then a short sale deal is probaly not a good option for them. The problem with short sales is that you cannot predict when and if the deal will close.
In conclusion, you must set your potential buyers expectations early on in the process. Sometimes short sale deals can take along time to close. Sometimes in a deal, there is a trade off, you the buyer may be getting a great deal, however you may have to wait 6 months or more for the deal to close. You must always prequalify the buyers and you must protect against them walking away from the short sale. You do this by by giving them something to lose if they intend to walk away,for example, a significant down payment that they put down. Buyers will walk away if there are no consequences against them should they decide to walk. You must make sure that the buyer understands that there are going to be consequences against them if they try to back out of the short sale deal. This will result in more closed short sales.
What is a HELOC you ask? HELOC stands for a 2nd mortgage Home Equity Line of Credit. When you take on a Short sale listing and you find out that there is a HELOC that will have to be negotiated, you just sigh because you know that the short sale transaction just became more complicated.
What is the difference betwen a true 2nd mortgage and a HELOC?
A true 2nd mortgage is typically used to purchase a home and is used as additional financing. They were very common a few years back during the sub prime days. They are loans only secured by the property and are usually wiped out if the first mortgage forecloses and there is not enough equity to pay them anything.
A HELOC is completely different in that while it does include a lien on the property, it is still a line of credit that can stay open even if the lien is wiped out in a foreclosure. HELOCS require special attention in order to do a successful short sale. Make sure the real estate agent you use when selling your property as a short sale understands how to deal with HELOCS in order to make sure you walk away with no liability.
It is essential to understand that HELOC’s are a completly different type of loan and the lender can allow you to do the short sale and release the lien on the property, but still leave the entire account open and this leaves the seller still owing the entire balance due.
HELOCS are are like credit cards with a lien on the property. If the lien is released from the property, it does not always mean the line of credit is closed.
RELEASE OF LIEN vs. FULL SETTLEMENT OF LIEN
In today’s market many banks are now selling the bad HELOC loan in the secondary market to investors for a higher price (10 to 30% of note value) than what the holder of the first mortgage is willing to pay them (1 to 3% of note value).
Real Estate agents need to know that a “lien release” which happens when both the first mortgage and HELOC are originally paid off does not necessarily mean that the seller is “off the hook” and walks away with no liability.
The seller can not walk away “clean” until the HELOC lender gives the seller a “full settlement” or ‘full satisfaction” of the lien. Most HELOC lenders will only give “full satisfaction” when they are paid the 10 to 30% payout that they demand.
Another thing that real esate agents need to know is that if the First mortgage will not pay out the amount of money that the HELOC demands in order for the HELOC to give “full satisfaction” of the lien, then other remedies need to be sought and worked out. Unfortunately the seller may have to bring money to the table or sign a promissory note in order to walk away free with no liability.
You must make sure when you are looking for a competent qualified short sale agent to always ask them if they are knowledeable about HELOCS and about how they will get you the seller out of the transaction with no liability.
Richard Lonschein, Esq. is a real estate Broker who specializes in short sale listings, if you want to ask him any questions
call him at 516-371-4705.
MARS (Mortgage Assistance Relief Services) is a guideline created by the FTC that became effective in January of this year which is designed too keep homeowners in distressed situations from being taken advantage of by fraudulent investors, agents, negotiation company’s etc. It consists of various disclosures that need to be made by various short sale professionals when they are looking to help distressed homeowners. If they neglect to provide these disclosures they can be fined up to $11,000 dollars a day. Let’s examine MARS and examine exactly what needs to be disclosed under the act.
The first part talks about disclosures that must be presented when “any and all “commercial communications” either written or orally stated that is designed to effect a sale or create interest in purchasing any short sale service, plan or program.” It is clear that any marketing directed to distressed homeowners including letters, post cards, and websites all must have the necessary disclosures under MARS.
Short sale professionals must also disclose
1) “your company is not associated with the government and our service is not approved by the government or lender.”
2) “even if you accept this offer and use our service your lender may not change your loan.”
you must also disclose that “you may stop doing business with us at any time. You may accept or reject the offer of mortgage assisstance we obtain from your lender. If you reject the offer you do not have to pay us. If you accept the offer you will pay us x amount for our services.”
Bank approvals are also covered by the program. You must also under the program explain the difference between the current loan against the short sale approval amount and Realtor Listing Agreements must contain language to the effect that the buyer has the right to cancel their listing agreeement at any time.
Some of the other consequences of MARS:
- homeowner no longer can pay any upfront fees
- homeowner has the right to stop doing any business with the provider at any time
-false or misleading claims are prohibited in advertising or communication about services or performance.
In conclusion, I have no problem with MARS. Unfortuanately there are always going to be a few bad apples in a bunch that are looking to take advantage of people and operate with no morals or ethics. and the more bad apples that are kept away from this business the better it is for good honest hard working people who are providing a great and valuable service for people who are in a distressed situations. Yes this will require a little more paperwork and disclosures, but in the end it is well worth it to keep the scammers out of this business so that distressed homeowners can feel safe that they are working with good legitamate and ethical people who are acting in their good faith and are looking out for the homeowners best interest.
Shortsales vs Loan Modifications
Before we contrast and compare these two alternatives to Foreclosure, let’s define what each option is.
A short sale is a situation where you owe more on your mortgage balance than what the value of the house is. In a short sale you sell your house and your lender agrees to accept an amount which is less than what is owed to them on your mortgage balance. Usually you hire a realtor who tries to sell the house, negotiate with the bank and find a buyer. In a short sale you decide to sell the house and cut your loses and walk away from a difficult situation.
When doing a Loan Modification you are asking the lender to alter the terms of your existing loan by modifying the interest rate, or reducing your payments, or increasing the term of the loan. To qualify you must show a legitamate hardship like unemployment, bad health, divoce etc. and fill out a bunch of paperwork.
In order to determine which option is better for you it is essential to look at your financial situation both today and into the future and analyze the potential consequences of each option. If you believe that you will qualify for a loan modification and would be able to afford your new monthly payments if they are reduced, then a Loan Modification might be your option.
However alot of people do not want to look at the reality and future consequences of trying to get a loan modification.
Reality#1 The loss mitigation departments at banks are unorganized and completly overworked and they are overwelmed by the never ending files they have to deal with, In fact many times your paperwork gets lost and you have to resend all of your paperwork again and restart the complete process all over again.
Reality#2 Most Loan Modification applications do not get approved. Most people cannot even survive the “3 month mock loan modification period”. Also The government’s attempt to encourage loan modifications through the HAMP program has been a complete disaster.
Reality#3 Even if you are lucky enough to get a loan modification the redefault rate is extremely high. A recent study was done where it was shown that 96% of the people who recieved an alteration of their mortgages, fell back behind their new payments in a 6 to 9 month time frame.
Reality#4 People do not like to look into the future, but if you end up in foreclosure your financial position will be horrendous. Your credit score will take a 250 to 300 point hit. The foreclosure will stay on their record for 10 years. They will not be able to get a loan to buy a new home for at least 7 to 10 years. The interest rates on their credit cards will be through the roof. Just trying to buy a car with credit will be extremely difficult and the list of bad things that occur if you fall into foreclosure goes on and on.
Some people think that filing bankrutcy is the way to go. The truth about bankruptcy is it stays on your credit for 10 years and if you do not payback your creditors you will be facing foreclosure all over again after 6 months.
I compare doing a loan modification to trying to put a tiny band aid on a huge gushing wound. Most Homeowners who are getting loan modifications are just delaying the inevitable.
If you choose to do a short sale your credit wil take a small hit but you will be able to purchase a new home with a loan in 1 to 2 years. It is possible to walk away from a short sale without owing the bank anything and also with no liability. This will save your financial future and allow you to get a brand new start in your life without the headaches that come with loan modifications and foreclosure. That monthly bill that you dread each and every month will be completely gone.
In conclusion if you make a decision that you cannot and will not in the future be able to afford your monthly mortgage bills, then you can talk to a realtor or attorney and let them help you do a shortsale which will allow you to walk away from a bad situation and get a fresh new start and avoid the negative consequences of foreclosure.
Before I get into why Loan Modifications do not work, Let’s define what a Loan Modification is. A Loan Modification permanently alters the terms of your original home loan in order to make your payments more affordable.
Even though this sounds like a good alternative to foreclosure in theory, however in its actual application by the lender or by the government, it simply does not work for many reasons.
1) First They do not provide a long term solution to the homeowner. The way it works is that you are given a “trial modification” that lasts 6 months or longer and during this period of time the bank strings you along and makes you think that you will eventually be getting the full Loan Modification, and unfortunately most of the time this is simply not the case.
2) Secondly, Banks make qualifying for a Loan Modification extremely difficult for the troubled homeowner. Banks operate on what is called a debt to income ratio. The way it works is if the debt to income ratio(monthly incoming income vs monthly expenses) is greater than 38% then the Loan Modification will be denied. In the bank’s eyes the homeowner usually makes too much money or not enough money to qualify. The bank wants to see if the homeowner will be able to afford the new payments. If the homeowner can not afford the the new payments based on their ratios or the bank believes the homeowner makes too much money to the point where the bank believes the homeowner should not even be behind on their payments to begin with, so the homeowner will be denied.
3) Thirdly, many banks are so overwelmed with the amount of Loan Modification applications coming in, that they often lose needed documentation and paperwork which is needed for the file, which results in many months of misinformation and because of the Bank’s ineptness, it ends up with the homeowner missing out on their opportunity to do a Loan Modification at no fault of their own and they eventually end up in foreclosure.
4) The reality of Loan Modifications is that that they often carry higher principal balances than they did on the original loan, what that means is that in the long run most homeowners actually end up paying more on the mortgage after a Loan Modification than what they are currently paying on the mortgage right now.
5) Loan Modifications do not improve the home owners negative equity on a home. Most homeowners are still underwater even after they get the Loan Modification,and they end up just walking away from the house.
6) Scammers- Many Loan Modification companies have popped up recently claiming they will help get the homeowner a Loan Modification and they end up charging illegal high upfront fees and either they do not get the positive results that they promise, or they do not even bother trying to make an effort to help the distressed homeowner get through this complicated process. The homeowner ends up losing the money they paid upfront to the crooked Loan Modification companies and end up right back where they started from and closer to foreclosure.
In conclusion, A recent study stated that around 96% of homeowners who got loan modifications fell behind on their payments again within 9 months. Whether it is a lender or the government(Hamp program) trying to help homeowners deal with these difficult economic times by trying to make mortgage payments more affordable, the results show that this option in it’s application has basically been a failure. In my opinion a Loan Modification can be compared to a small band aid in that is trying to be applied to a gaping wound. Right now the Loan Modification option simply does not fit the foreclosure problem and it is clearly not the answer that distressed home owners need.
When you take a short sale listing from a seller, you must understand that the traditional rules associated with selling a property do not apply. In a “normal” deal, getting the highest offer for the seller is what you as a realtor are trying to accomplish. This rule does not apply in a short sale tranaction.
It is essential that realtors understand that you do not represent the bank in short sale transactions, your obligations are strictly owed to the seller only. The Bank in these type of transactions are actually in a adversarial position against the seller in a short sale. Your fiduciary duty is owed to your client, the seller only. Your duty is to get the best possible outcome for the seller.
You must remember that the bank does not own the house, they own the note which is given to the seller. The bank wants to recoup as much money as they can, which is completely different than what the seller wants. Your obligation as the realtor, is to get the seller out of this situation with the least amount of damage done to your client as possible.
Many agents allow the bank to control the entire process because they think that the bank is doing them a favor by accepting a short sale. You cannot let the bank boss you around and try to control the deal. Many agents who take on short sale listings are violating their fiduciary duty to the seller, because they are looking to please both the seller and the bank. It is the seller’s interest only that you are negotiting for on a short sale.
You must understand that you owe no such duty to the bank. Remember the highest offer is not always the best outcome for the seller. In a short sale the seller is not supposed to get any money from the sale. So Your obligation is to accept an offer that provides the best possible outcome for your client, which would be walking away with no liability and a full releases from any deficiencies owed.
In conclusion, you the realtor represent the best interest of the seller, your client. You owe no such obligation to the bank. The highest and best offer are not always the best offer for seller in a short sale. Your obligation as a realtor in a short sale is to protect the seller’s interest and see to it that your client walks away with no liability and no money owed. This is your fiduciary duty.
It used to be that if the homeowner conducted a successful short sale, the amount forgiven by the lender was treated as income and taxed by the IRS.
For example if the mortgage balance was 200,000 and the lender accepted 170,000 then the lender would issue a 1099 for 30,000 the homeowners gain from the short sale.
The Morgage Forgiveness Debt Relief Act of 2007 which is good until 2012 changed that.
1) it allows the homeowner to exclude up to 2 million or 1 million if you are married and filing seperately.
2) Relieves the homeowner of any potential liability in regards to the shortfall that may occur in a short sale. the relief is only available to you if you are using the property as your primary residence.
3) Even if the property is not your primary residence you can still be excluded from paying any taxes on any gain from a short sale if the borrower can prove insolvency. Insolvency exists if a person’s debt exceeds their existing assets. These people could be absolved from paying any taxes on any gain from the short sale with the use of IRS form 982.
I believe the act is fair especially at this point and time, with our struggling economy. The purpose of a short sale is to allow people who are going through hard times, to be able to get a fresh new start in their lives, and making them pay more in taxes would be very unfair considering these current rough economic times.
Is Short sale flipping illegal? The answer to this question is no short sale flipping in and of itself is not illegal, it all depends on how it is done. Firstly, I am going to give you an example of a short sale flip transaction which is done correctly and is completely legal. You find through your marketing efforts a homeowner who has lost his job and is now facing foreclosure. He signs a authorization to release giving you the power to negotiate a short sale with his lender. You disclose to the lender during the negotiation process and in the contract that your intention is to purchase the property and then quickly resell it the same day for a profit. Every relevant party is notified about the deal and they all know exactly how it will be done. The homeowner knows it, their short sale lender knows it, the end buyer knows it and if the end buyer is using a lender and they know it. You have disclosed to all parties that that you are a investor and that you will take title to the property just prior to selling it to the end buyer. There are two distinct closings and each closing is seperate and stands on its own. In the first closing you purchase the property from the homeowner with cash and then a few minutes later you sell the property in the second closing to the end buyer.
So what you have is two completly seperate and distinct transactions and it does not matter if the closings took place on the same day and whether it happens just 5 minutes apart or 5 years apart, the time between closings is completely irrelevant. It should also be noted that this is not a simultaneous closing where the funds received in the b to c transaction are used to fund the a to b transaction. Most states will not allow that type of transaction anymore. In our example, the two closings are set up to occur right after each other on the same day and every person that is part of the transactions are all made aware of what is going to take place way before the scheduled closing date. There is absolutely no deception or concealing of material terms.
Now let me give you an example of a flip that would be looked at as fraud. An investor finds a person who wants to buy a property. The investor would then sign a contract with this person who will be the end buyer in the b to c transaction. The investor then approaches a homeowner and they sign a contract to do a short sale. The investor never informs the home owner that he has a contract already with a end buyer, and he never discloses to the home owner’s lender that he already has a end buyer. These type of investors put themselves in the middle of the transaction between the homeowner and the end buyer and they collect the difference as their profit. This is absolute fraud. You cannot find and sign a contract with a end buyer first and then find a homeowner to sign a contract and flip the property without providing any disclosure to the home owner or the home owner’s lender. This would constitute fraud. Another example of fraud would be bumping up and fixing appraisals, and using straw buyers etc. In a correctly done short sale flip there are no surprises and every relevant party to the transactions, understands how the deal will take place and what their role in the transaction will be.
Investors are a very important part of todays real estate market. Right now there are many more houses on the market then there are buyers. Alot of investors purchase distressed houses and alot of times these type of distressed houses have been vacant for a long time and need alot of work, which bring down the value of neighboring properties. However Investors purchase these preforeclosures and fix up and rehab these distressed properties,which in turn helps the struggling real estate market and directly results in increasing the value of the homes in the immediate neighborhood
Now the term “flipping” has become a negative term because of Freddie Mac, Real Estate Agents and the Government. However buying houses and quickly reselling them for a profit is completely legal and has been done for a very long time. It is the same thing as if you buy and quickly resell cars for a profit. Flipping (also known as “quick turning properties” ) is completely legal and as long as it is done correctly with full disclosure, there is absolutely no fraud taking place.
In conclusion, there is nothing illegal about short sale flips and back to back closings. The two closing are completly seperate and distinct from each other. The numbers are diferent and each closing has their own Hud1 statements. People have to understand that distressed properties lower the current market value of a property. Freddie Mac may makes a claim that buying and selling a property within 30 days is a ‘potentially fraudulent sale,” what they fail to take into consideration is that distressed properties sell for lower amounts than normal properties do and failing to understand this difference between distressed properties(either physicallyor economically because of a foreclosure situation) and a non distressed property is shortsighted and does not take into consideration the state of todays real estate market. Distressed houses can usually be purchased at discounts which is why investors search for and buy foreclosure properties.
Remember flipping is not a negative term and flipping short sales is completely legal as long as everyone involved in the transaction is made aware of all aspects of the deal. If a real estate agent you are working with makes a statement that “short sale flipping is illegal”, ask them to show you the law that says short sale flipping is illegal. Is there a statute, is there case law backing up this statement? The answer is no. Flipping in of itself is not illegal as long as it is done in the correct manner.
So remember when it comes to short sale flipping the three most important words are not location, location, location, they are disclosure, disclosure, disclosure.
