Don’t Get in Trouble Flopping a Short Sale

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With the declining number of REO foreclosures on the market right now, many investors and wholesalers are having success acquiring properties through short sales. However, dealing with REO foreclosures and short sales can be two very different animals. While buying and selling an REO is typically straight forward, the laws surrounding the reselling of a short sale are quite different.

For those new to real estate: a short sale is a real estate transaction in which the seller has received approval from their lender to sell the property “short” of the actual loan balance (i.e. for less than what is owed on the mortgage).  For example, you may owe $100,000 on your mortgage, but values in the area have fallen and the house is worth less than this. Rather than getting foreclosed by your lender, you sell the property for $70,000 and the lender agrees to accept $70,000 as payoff of your mortgage.

Many investors gravitate towards short sales because there is often an opportunity to buy and sell the property for a profit (similar to a foreclosure). Sometimes this involves buying a property in need of repair, renovating it and selling it for a profit. Sometimes this may simply involve negotiating a good deal with the bank and finding a buyer who is willing to pay more.  Interestingly, this second scenario is typically illegal and can land an investor in serious trouble.

Most investors will read this and think to themselves , “Why would it be illegal for me to negotiate a good deal on a short sale and simply mark it up to another buyer?” Believe it or not, Freddie Mac considers this “short payoff fraud”.  They define short payoff fraud as; “Any misrepresentation or deliberate omission of fact that would induce the lender, investor or insurer to agree to the terms of a short payoff that it would not approve had all facts been known.”  In most cases, the fraud occurs because the investor does not disclose to the lender the fact that there is another buyer involved in the transaction.

In the example above, suppose the property is sold to the investor for $70,000, but the investor has an offer from another buyer for $80,000. The investor plans on reselling the property immediately after closing for a quick $10,000 profit.  If the investor discloses to all parties that his/her intention is to sell the property for $80,000 and everybody agrees to this arrangement, then there is no problem. However, this is typically not how the scenario plays out. Most investors don’t even realize they are committing fraud, but by not disclosing the transaction whereby the investor sells the property to another buyer for $80,000, the investor commits fraud (by omission) and can get in serious trouble.

I realize most investors will argue that a good negotiator should have the ability to earn a quick buck for getting a good deal on a property.  I’m a staunch capitalist and tend to think this way as well.  However, when it comes to getting into legal trouble, I’d rather understand how the courts interpret “fraud” and do my best to stay as far away as possible.  This is one of those topics where being an educated investor isn’t just about being profitable, it’s about staying out of trouble!

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About Author

Ken Corsini G+ is the founder of Georgia Residential Partners, LLC - a real estate investing firm based in Atlanta, Ga focused on creating turn-key investments for investors all over the country. He's been investing in real estate since 2005 with hundreds of real estate transactions.

3 Comments

  1. To me this says we can’t wholesale a shortsale. Then just do some rehab and show you added value with before and after pictures. Same thing is in play (just not in a legal sense) with a rehab and the buyer’s bank get’s cranky about your mark up in a zipcode that had past fraud. Just need before and after pictures.

    Might this be what you’d recommend?

    curt

  2. How does the fraud issue work when you don’t immediately have a buyer lined up? Is there a holding period? Do you still have to disclose to the bank you plan to re-sell for a profit?

  3. William Bronchick, ESQ on

    I think this is nonsense. If I buy a property through a short sale and resell it a year later, it’s not fraud. A month later, no fraud. A week later, no fraud. Why does it suddenly become fraud if I sell it a day or an hour later? The lender is not the seller, they are the LIEN HOLDER. We owe them NO DUTY to tell the what we plan to do with the property once we acquire it. Unless there’s a contractual limitation on the resale or an affidavit they make you sign that REPRESENTS you have nobody lined up to buy it from you (which is becoming more common), then what have you misrepresented by not telling them you have a buyer lined up to purchase it from you at a higher price?

    These arrogant lenders are of the outrageous opinion that they are “losing” money by not getting the higher price that you are getting on the resale. This is fallacious reasoning because they are not the owner of the property and have no right to sell it. The investor created value by FINDING A BUYER who is buying it at a higher price. The lender cannot do that because THEY DON’T HAVE THE RIGHT TO SELL THE PROPERTY.

    Further, some have actually argue that it is a scam to the BUYER who paid more for the property than the investor shorted for an hour ago. Of course, nobody mentions that the ultimate resale price of the property was still WAY UNDER MARKET.

    I’d like someone to point me to a law, case, statute, ordinance or regulation that is violated when a resell a property for a property without disclosing it to the lender?

    EXCEPTION: Colorado has actually passed a law that DOES require this disclosure if the property is resold within 14 days. Who exactly are they protecting with this law?

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