Short Sales: Fertile Ground for Fraud

The effects of the 2008-2011 housing collapse continue to be felt across the US, as foreclosures percolate through the courts and lenders, as homeowners struggle to make monthly mortgage payments. This shadow side of the rebounding housing market has spawned a number of frauds and scams preying on desperate homeowners – none, perhaps, more so than the sell low, buy fast market of short sales. These frauds can trap sellers, lenders – and buyers too, investors eager to snare a good property for cheap.

The short sale market thrives on uncertainty and fear. Prime candidates for short sale fraud are usually homeowners barely staying afloat with monthly mortgage payments or completely underwater: unable to pay and facing foreclosure. These sellers are generally desperate and in a hurry to extricate themselves from the housing problem.

Since short sales involve a shortfall in the mortgage, these kinds of sales must be approved by the lender, who faces losing money on the sale. In some states, lenders can pursue the shortfall between the selling price and the mortgage value as a debt for collection; in others, it can be written off as long as the lender gets what money they can from the deal.

Sellers typically must show that a property won’t sell for its asking price and ask the lender to accept a lower sale price, one which is generally thousands of dollars below the mortgage value. That leads to the practice of “flopping” houses, in which the seller actually defaces the property or falsifies problems in order to force a sale at a very low price.

But that’s not the only problem an investor can get caught in. Undisclosed payments to any parties outside of the short sale agreement can also constitute loan fraud. Typically in order to approve a short sale, lenders place constraints on the deal. One of these requires that the seller receive no financial benefit –that all the proceeds go toward the mortgage. But sellers can arrange payments “outside of escrow” from parties such as negotiators and attorneys. These payments, which aren’t reported as part of the income from the sale, are fraudulent and illegal, and an investor arranging to purchase the property must make sure that no “off the table” funds are involved.

As a result of the housing collapse and the foreclosure epidemic, the short sale industry has spawned a number of predators seeking to profit from desperate, confused homeowners trying to extricate themselves from the trap of their mortgages. The “short sale negotiator” offers these homeowners a variety of largely unnecessary services including help with the lenders short sale paperwork, finding a buyer, handling negotiations with buyers and resolving debt issues.

Short sale negotiators warn homeowners that they can’t complete the sale without their services, charge a hefty fee and then may disappear. Although a few states require these kinds of negotiators to be licensed, most don’t. While investors may not directly experience this fraudulent practice, they can be affected by it if complaints are made or the sale is held up due to an investigation.

Short sales can yield viable income property sales – and may even help a struggling homeowner. But federal and state investigators, as well as real estate professionals, warn that this kind of property transaction is especially vulnerable to fraudulent practices.

Investors considering such a purchase need to follow Jason Hartman’s investing commandment to become educated and seek qualified legal advice to avoid being trapped in short sale fraud. (Top image: Flickr/D'oh Boy (Mark Holloway))

The American Monetary Association Team

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