Avoiding Short Sale Fraud: Disclosures to the End Buyer’s Lender

If you ever doubted the need for disclosures, you probably never stared down the barrel of a full-blown lawsuit filed by an unhappy buyer or seller. It’s not pretty. For real estate investors who don’t care to go through that, here are some things to watch.

The end buyer’s lender needs some special disclosures before they will agree to fund the B-C transaction. When you’re a real estate investor on the second leg of two back-to-back closings, you may find that disclosing these material facts makes that lender feel a whole lot better about loaning that money.

Obviously, you have to disclose that the sale is “subject to a short sale that is satisfactory to the seller.” Also disclose that “the short sale must be completed or closed (in the A-B transaction) before the closing of this transaction.” That goes in the purchase and sale agreement in your B-C transaction, and leaves no doubt that this is a transaction dependent on the original homeowner’s progress through the foreclosure process.

The next disclosures to the end buyer’s lender will be built right into the title commitment. Prepared by the title agent or an attorney, the title commitment will be very clear about the current status of any legal proceedings or foreclosure on the property. Everyone who has had a vested interest in that property for the past 24 months, especially the homeowner in default, will also be listed on that title commitment.

That title commitment should also disclose your relationship as a real estate investor with the property. Make sure that your option contract - your option to purchase that property - is listed as an exception to the title in Section 2, Part B, of the title commitment.

If there is any type of deed delivered by the owner in default/foreclosure being held in escrow by the title agent or title attorney, then that should also be disclosed in the title commitment or in a separate written letter to the end buyer’s lender.

Finally, the title agent or attorney might add one more disclosure in the title commitment that gives everyone, including the end buyer’s lender, adequate written notice of the entire nature of the transaction(s). This would be a listing of all documents that will need to be prepared, executed, and recorded to complete both transactions. The list should include:

1) a deed from the homeowner in default (vested owner) to the investor;
2) release of all current liens and dismissal of foreclosure if any;
3) a second deed from the investor to the end buyer so as to release/satisfy the recorded notice of option; and
4) a mortgage then given by the end buyer to the lender, who is ordering the title commitment.

That list of documents can reassure everyone that not only will there be two separate transactions, they will both be conducted honestly and legally.

If you’re new to real estate investing, you’ll want to talk to other investors who have been through this before. Click here to start some great conversations about how you can feel more confident about discussing these documents and disclosures with people.

For instance, if the B-C lender asks about the first transaction’s purchase price and profit spread, just tell them. They’ll understand the concept of making money by orchestrating these types of transactions. They’re just trying to make sure their investment will be sound as well.

Do whatever you can to disclose the necessary facts to the parties in both the A-B and the B-C transactions without violating the confidential nature of each separate transaction. You’ll have a much smoother closing - and you won’t be staring down any barrels later.