Short Sales: 7 Legal Pitfalls

In addition to educating yourself on the ins and outs of these complex deals, you also need a good picture of the legal risks that exist for you.

 1. Misrepresenting tax consequences.

Although it’s true that the federal government passed a law in 2007 directing the IRS not to count mortgage debt forgiven by a lender as income, the provision is limited. It applies only to purchase money; it doesn’t apply to debt on a cash-out refinancing, and it doesn’t apply to second homes. There’s also a dollar limitation, albeit a generous one ($1 million for married couples filing separately, twice that for joint filers). “A lot of associates are telling people there are no tax consequences,” says Lance Churchill, a short sales specialist and trainer who operates in Boise, Idaho, and San Diego. “But it’s a limited law and you just need to be accurate about it.”

2. Misrepresenting how secondary debt is treated.

Practitioners might mistakenly tell sellers that all the house debt is forgiven once the primary lender approves a short sale. But that might not be the case, Churchill says. Holders of second deeds of trust don’t typically forgive the debt. More commonly, they accept a partial payment, like $2,000; and rather than write off the balance, they sell the balance to a collection agency for another few thousand dollars. In many states, these second loans are recourse, so sellers can be caught by surprise when the collection agency contacts them a year later seeking payment of the debt.

3. Acting on inappropriate lender requests for seller contributions.

It’s not uncommon for lenders to go after money that the sellers have in the bank or in a retirement account before they approve a short sale request. They’ll sometimes seek to put the onus on the real estate practitioner to get sellers to sign over a note for the amount they have in the bank as a condition of sale. But in states where mortgage debt is nonrecourse, lenders have no right to the money, and associates that suggest otherwise to the sellers might be later sued for negligence.

4. Breaching fiduciary duty.

Investors are increasingly executing what’s known as a “double close and flip,” a type of short-sale transaction that can leave practitioners exposed to irate sellers who say they got a raw deal. Here’s what typically happens: Investors insist on handling short-sale negotiations with the lender, freeing up their real estate practitioner to concentrate on finding a buyer. During the negotiations, the investors—often without the practitioner’s knowledge—talk the sellers into turning over the deed. Once the practitioner finds a buyer, the investors do a double closing, buying it themselves at a deep discount and then flipping it to the buyer at the listed price, making money on the spread. “The seller might feel he got less than he would have had the associate done his job and not handed over negotiations to the investor,” says Churchill.

5. Providing poor oversight of a loss mitigation company.

Companies that specialize in managing short sales promise to focus on the complicated details of the short sale, freeing up practitioners’ time to find buyers. But if you take a hands-off approach, you can be charged with negligence if a deal falls apart. “A lot of these companies are fly-by-night or have one person who’s overworked,” Churchill says. “Practitioners are coming back a month later to find no one’s even opened the file.”

6. Lacking the required license to undertake loss mitigation.

It often makes sense for practitioners to take a two-pronged approach with clients facing a difficult time paying their mortgage—first trying to help them accomplish a loan modification (for a fee), and then finding a buyer if a modification doesn’t work. But watch out. Depending on your state, you could need a specific license, sometimes called a credit repair license, to earn a fee for helping owners modify mortgage terms. Without having the right credentials, taking a fee for loan modification assistance could be a criminal offense.

7. Facilitating transactions not listed on the HUD-1 form.

It’s not uncommon for investors to offer incentives to sellers to move a deal forward, but lenders typically frown upon sellers who walk away with money when they’re supposedly taking a loss. Investors sometimes work around this limitation by offering to buy something from the sellers at an attractive price, such as a couch for $5,000. Associates who communicate these offers to sellers can get tied into charges of lender fraud because the deals may be deceptive.

Source: By Robert Freedman (April 2009)

Advertisements

5 Real Estate Scams You Need to Know About

Mortgage fraud is pervasive: An estimated $4 billion to $6 billion in annual losses result from mortgage fraud, according to FBI reports. “An entire community can be damaged by mortgage fraud,” says Rachel Dollar, a lawyer from Santa Rosa, Calif., and editor of the Mortgage Fraud Blog. Mortgage fraud can lead to a spike in foreclosures, home values plummeting, and lenders raising their rates and fees to recover losses.

The crimes are often complex, involving several parties and occurring over multiple transactions. To protect you and your clients, educate yourself about mortgage fraud and be on guard for any warning signs in a transaction. You can start by reviewing these five scams, and then test your knowledge by taking our Mortgage Fraud Quiz.

1. The Foreclosure Rescue Scheme

The Scam: “Rescuers” promise cash-strapped home owners that they can save their home from foreclosure. The rescue, which involves paying upfront fees, can take multiple forms, such as the perpetrator obtaining a new loan on behalf of the owner or by having the owner sign over the home’s deed and then rent the home until they can repurchase it. Eventually, the home owner loses the home, either to foreclosure or the fictitious rescue company.

Red Flags: With foreclosure rescue programs, borrowers are often advised to sign over the title of their house to a third party, become renters of their home, not contact their lender, or send mortgage payments to a third party, according to Fannie Mae, which provides fact sheets on mortgage fraud.

2. Loan Documentation Fraud

The Scam: This fraud involves numerous schemes in which a borrower provides inaccurate financial information — such as about their income, assets, and liabilities — or employment status in order to qualify for a loan with lower rates and more favorable terms. Occupancy fraud is one growing area: Borrowers say they plan to live in the property when they actually intend to rent it.

Red Flags: Documentation may raise suspicion if the employer’s address is shown as a post office box, accumulation of assets compared to the person’s income appears too high or low, the new house is too small to accommodate occupants, the person has no credit history, or the application is unsigned or undated, according to Fannie Mae.

3. Appraisal Fraud

The Scam: A faulty appraisal — saying a property is worth more than what it really is — is connected to many types of mortgage fraud. It entails manipulating or overstating comparables, market values, or property characteristics in order to obtain a higher appraisal. The higher property appraisal, which generates false equity, is done by falsifying an appraisal document or using an appraiser accomplice to obtain the higher value.

Red Flags: Be skeptical of appraisals that are dated prior to the sales contract, list comparable sales that do not contain similarities to the property or are outside the neighborhood, the owner is not the seller listed on the contract or the title, or a third party participating in the transaction orders the appraisal, Freddie Mac warns.

4. Illegal Property Flipping

The Scam: This entails purchasing properties and reselling them at inflated prices. These scams usually involve faulty appraisals and inaccurate loan documents. The property is then refinanced or resold immediately after purchase for an inflated value. The home is purchased at a higher price, often by straw buyers working with the “flipper,” and eventually falls into foreclosure. 

Red Flags: Some key things to look for are rapid refinancing of a property; the seller recently having acquired the title or acquiring the title concurrent with the transaction; an appraisal that comes in too high; a property that was recently in foreclosure being purchased at a much lower price than its sales price; or the owner listed on the appraisal and title not matching the seller on the sales contract, according to Fannie Mae.

5. Short Sales Schemes

The Scam: Borrowers owe more than the current value of their home so they fake financial hardship and no longer make their mortgage payments. An accomplice of the borrower then submits a low offer to purchase the property in a short sale agreement. The lender agrees to the short sale, unaware that it was premeditated. The property, after being purchased at the reduced price, is then often resold at the home’s actual value for profit.

Red Flags: The borrower suddenly defaults on the mortgage with no workout discussions with the lender, an immediate offer is made to a lender at a short sale price, the short sale offer is less than current market value, or a cash back is offered at closing to the delinquent borrower (disguised as “repairs” or other payouts, for example) and is not disclosed to the lender, according to Fannie Mae

Source: By Melissa Dittmann Tracey (August 2010)