Working with a Short Sale? Better Watch the ‘Arms-Length Affidavit’ Carefully…
Many investors have found that REO inventory is drying up and more and more short sales are being listed on local MLS databases. I suppose after 5 long years drudging through distressed inventory, banks have finally figured out that short sales just make more sense in most cases then foreclosing. That’s not to say that banks have sped up the short sale process, but at least the general trend seems to be headed in that direction. (Interestingly, I just had a short sale approved on a property I’ve been negotiating since January of 2012 … only took 17 months!)
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With that said, new investors need to be VERY aware of the rules and risks associated with buying short sales. Many wholesalers are accustomed to double-closes and other creative techniques for selling properties that they have contracted or control. It is important to understand that short sales are a completely different animal.
One of the most important components to a short sale purchase is the arms-length affidavit. This is a document put together by the bank that owns the mortgage on the property. The purpose of the document is to highlight and disclose any relationships between the buyer, seller, agent, etc. and outline the parameters by which the bank is willing to agree to the short sale. In essence, it's the document that spells out the guidelines that a particular bank has set forth for a specific short sale.
What’s the Purpose of the Arms-Length Affidavit
Most banks will tell you the purpose of the arms-length affidavit is to prevent mortgage fraud. A common example might be as follows: John and Kate are upside on their home and are having trouble making the mortgage payments. John asks his dad to step in and buy the house from the bank on a short sale at half the price of his current mortgage. Once his dad has purchased the house, John and Kate would either buy it back (at half the price of their original mortgage) or rent it from him so they can stay in the house.
As an investor, it’s important to look closely at the affidavit for a given property to make sure you are sticking to the agreement. While you may not be related to the seller, I’ve found that it’s not uncommon for sellers to ask to rent the property back from the buyer. As an investor, it may seem perfectly harmless (and convenient) to keep the seller in the home as a renter. However, most arms-length affidavits have a provision specifically stating that the buyer cannot rent the property back to the seller.
Also, most affidavits have a resell restriction limiting the buyer’s ability to resell the property within a given time-frame. The most common provision is a 90 day hold period whereby the buyer is unable to resell the property within the first 90 days of purchasing it. However, I’ve seen some for 30 days and some for 60 days.
Other Provisions in an Arms-Length Affidavit
- Disclosure of family and or business partner, common business interest
- Prohibition of undisclosed arrangements or agreements between buyer and seller
- No additional compensation paid or received by any of the parties other than commission to agents that are disclosed on HUD1 Settlement Statement
It’s imperative that investors understand that this agreement is binding and not to be taken lightly. Any breach of the agreement can constitute mortgage fraud and land you in very hot water. It’s critical that any purchase of a short sale be analyzed carefully to know when the property can be resold, who it can and cannot be resold to, and that there are no “side” agreements that could potentially place you in violation of the arms-length affidavit.
Photo: Debra Drummond