What is Short Sale Fraud and How to Avoid it

I have bought a lot of short sales in the last ten years as rental properties or flips. Short sales can be terrific deals and provide instant equity, but the FBI is cracking down on short sale fraud. Short sales must be handled very carefully and you should always use professionals to complete the transaction. On a short sale the bank is agreeing to take less than they are owed and you must follow their rules or it could be considered fraud. All the short sales I have purchased have been listed on the MLS with another Realtor representing the seller.

I am not a lawyer nor I am giving any legal advice. For specific short sale questions please consult an attorney.

What is a short sale?

A short sale is when a house is sold and the bank or lien holders have to take less than they are owed. The lien holders will allow a short sale because they figure it is better than foreclosing on the home. A foreclosure can be very expensive and most banks do not want to foreclose on home owners if they can avoid it.

The big difference between a traditional sale and a short sale is the bank has to approve the short sale. In a traditional sale the owner of the home has control over the price and terms of the sale. With a short sale the bank has to approve the terms and price, because they are agreeing to take less than they are owed.

Because the bank is taking less than they are owed, all terms and conditions of the sale must be disclosed to the bank and the bank gets to make the rules. If anything seems fishy on a short sale, there is a chance fraud is being committed. I will go over some of the more common short sale fraud scenarios in this article, but if something seems odd consult a lawyer and inform the lien holders what is happening.

What is short sale fraud?

Short sale fraud is when the bank agreeing to a short pay off is defrauded of money. They are agreeing to take less money than they are owed and if they are deceived in any way it could be considered fraud. This is a very broad description and you must be very careful with short sales. Here is a great page from Freddie Mac on short sale fraud.

If you are the buyer, seller, agent or a third-party to a short sale you must be very careful you aren’t a party to fraud.

The most common short sale fraud cases are:

Wholesaling or flipping a short sale without disclosure: If you have a house under contract as a short sale and have another contract to sell that house to a third-party it has to be disclosed to the bank. Wholesaling is when an investor will buy a house and then assign the contract complete a double closing (selling the house the same day as you bought it). If an investor has a short sale under contract as the buyer and has another contract to sell the house to a third-party it must be disclosed to the lien holders. The lien holders want to know they aren’t taking $20,000 less than market value so that an investor can make $20,000.

If you are an investor buying a house to flip and you disclose you are an investor and have no contracts to sell the property while you have it under contract as a short sale you are probably fine. I have bought short sales as flips many times, but I always ended up making repairs and did not sell the house until months after I had bought it. The big issue comes up when the bank does not know you are immediately selling the house for much more than they agreed to sell it for without disclosure.

Manipulating a Broker Price Opinion (BPO): When a bank goes through the short sale process they ask the listing agent to complete a BPO on the property. A BPO is an opinion of value from the agent and similar to an appraisal, but not as detailed. The bank will also ask another agent to complete a BPO on the property as well (I complete many BPOs myself on short sales). If the listing agent or the third part agent manipulates their BPO in any way to try to show a lower value to the bank than what they home is worth it can be considered short sale fraud.

I have been approached by many investors or agents who give me comparable properties to use in my BPO or want to talk with me at length on why a home is not worth as much as it appears to be worth. When I do a BPO I am given strict instructions from the companies that hires me to never take a comparable property from anyone associated with the short sale. I can only use material facts known about the property and I am to come up with my own comparable sales and listings to come up with a value. I have had some agents or investors meet me at a house and give me comps that were miles away and in horrible condition compared to the short sale to try to change my value. This could be fraud, because the value is being artificially lowered to try to get the bank to take an offer less than would if they knew the true value.

Another trick that some agents or investors use is to stage a home to look like it is in disrepair. If you make a house look really messy or appear to have repairs needed that are not needed that could be short sale fraud as well. Many people will also inflate the cost of the repairs to the agent performing the BPO to try to lower the value.

If you, an agent or any third-party is trying to lower the value of the BPO by providing comparable sales, false staging, false repair reports, or anything else that artificially lowers that value it could be fraud.

Non Arms length transactions: Some property owners saw the values of their houses drop significantly during the housing crisis. It is no fun to see your house lose 40 percent of its value in a couple of years. In order to get equity back in their house some home owners will attempt to short sell their house to a friend or relative and then buy the house back for a much lower price. This is also short sale fraud in most cases if it is not disclosed to the bank.

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Undisclosed fees or payments: In any real estate transaction that involves a loan, all fees and payments involving the transaction should be disclosed on the HUD 1. The HUD 1 is a closing document that shows all the costs and payments made on a house sale. If there is a third-party taking a fee from the buyer that is not on the HUD 1 that could be fraud. If there is a kick back to the seller from the buyer that is not on the HUD 1 that could be fraud. The HUD 1 is meant to inform all parties who is paying what. If payments are left off the HUD 1 it usually means someone is trying to deceive someone and it could be fraud.

Not following the lien holders instructions: When a short sale is started by the seller of a house they usually receive a short sale packet that explains the process. The lender will want the seller to use a real estate agent, they will want a ton of documentation on financial abilities, why they need a short sale and they will tell the seller and agent how to sell the house. In many cases the lien holder will require the short sale be listed on the MLS in order to get fair market offers on the house.

If an agent already has a buyer and they do not list the house on the MLS it could be fraud if the lien holder is told the house was on the MLS. Or if the listing agent places the home on the MLS system, but does not allow any showings or present any offers to the lien holder that could be fraud as well. The seller has the right to sell the house or not, but because they are asking the lien holder to take less money than they are owed, they have to follow the lien holders rules. If the seller or listing agent does not follow the rules the lien holder lays out, they lien holder should be notified and agree to the changes in writing.

How can you avoid fraud on short sales?

There are a lot of things that can be considered fraud on a short sale. It can be pretty intimidating for some buyers to attempt to buy a short sale because of the process. Short sales can be great deals if they are done correctly and everyone is informed of everything that happens. Fraud basically comes from a buyer or seller of a short sale trying to get the lien holder to take less money than they should, because someone was hiding information.

Here are a few tips to avoid fraud.

• Everything should be in writing and disclosed
• No one should be trying to manipulate the value on BPOs
• Every payment should be on the HUD 1
• All contracts and offers associated with the property should be disclosed to the lien holder
• Make sure all documents from the lien holder are coming from the lien holder and not a third-party
• Make sure no one is related to anyone else in the transaction and if they are that the lien holder was disclosed of the fact.

How can investors buy short sales with all these restrictions?

My web site is geared towards real estate investing and making money with flips or rental properties. Short sales are a great way to buy houses below market value, but investors have to be very careful. Many investors will find sellers who want to sell their house, but owe too much money to make the deal work. A short sale seems like a great way to get a great deal on the house and is win/win for the seller and buyer. However, the lien holder is the one who will be losing money in a short sale and they have to be informed of everything and agree to the deal.

If you find a seller that wants to do a short sale, always use a real estate agent to complete the short sale and it is better if there is one agent representing the seller and one representing the buyer. The home should be listed on the MLS and other buyers should be allowed to make offers on the home, if those are the guidelines the lien holder says must be followed. It may not seem fair that an investor found a property to buy and negotiated a price, only to have another buyer come in and make a higher offer. But, the lien holder has the right to recover as much money as they can and the seller and buyer must follow their rules.

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