Avoiding Short Sale Fraud: Disclosures to the Foreclosing Lender

Here’s a scenario for you. You’re right on the verge of getting a foreclosing lender to approve a short sale for a client of yours. You think you have it all wrapped up, and then they ask why you’re buying the property. What do you say?

The answer to that is the subject of an intense debate in the short sale industry. Of course, the lender feels like they have the upper hand and won’t approve the short sale unless you tell them everything. On the other hand, you’re tempted to tell them, “Don’t worry about it.” What do you tell them, and why?

We asked the same question, and our attorney, Jeff Watson, gave us the answer once and for all. (Read more about it on the Strategic Real Estate Coach website.) You have to like his answers because he can back them up with both legalese and common sense.

First of all, the foreclosing lender really should know who is buying the property in question. Knowing the nature of the transaction helps them to make an educated judgment about the buyer’s commitment to closing the sale. The bank is in it to make money, just like you. Neither one of you would be completing the transaction if you didn’t think it was going to be profitable.

There are two things you need to tell them about your involvement with the short sale.

• You, the buyer, are a real estate investor seeking to make a profit.
• You, the investor, can and may promptly resell the property.

The bank also requires that the buyer of the foreclosing property be the same one whose offer was accepted, and that the deed be legally transferred from seller to buyer. We have no problem with that.

That’s where the foreclosing lender’s involvement with the investor ends.

Some lenders and title insurance underwriters believe that certain details about the resale of the property need to be disclosed, such as the investor’s gross profit from the second transaction. If they want two separate transactions, they have to agree that confidentiality rules supersede this belief. What happens in each transaction stays in that transaction.

There are some rules that you can implement at closing that will help both the lender and the title company feel better about completing your short sale transaction.

• There must be zero or negative equity in the property (proven by gross and net payoff letters, showing that the final sales price minus actual total amount of debt equals zero or less).
• No cash may be given back to the homeowner at closing.
• The second sale must be an arms-length transaction in which th end ebuyer is unrelated to original homeowner.
• The original property owner must sign the HUD-1 in person at closing, proving that they are aware of the investor’s intentions and that they are okay with that.
• Written evidence must be provided by the buyer’s funding lender that he or she knows about the two transactions linked by the investor.

As of this writing, I haven’t seen any state law, federal law, mortgage terminology, or common promissory note language that entitles the short sale lender to know about the physical or financial details of what happens to the property after the short sale.

Once the mortgage or lien is released, the bank is out of it. And, as long as the investor has given full and accurate disclosure of everything else, that’s the way it should stay.