Posted over 9 years ago Freddie Mac Short Sale Fraud: Much Ado About Nothing? Over the weekend, Freddie Mac published an informational article discussing what it has called, “Short Payoff Fraud”.This article tipped off quite a bit of anxiety among investors and agents. Many are suggesting that this new classification of “Fraud” effectively eliminates the A to B – B to C transactions which investors often use to “flip” short sale properties.Well, I read the article, and I think everyone is making a big deal out of nothing. Here at Short Sale Artisan we always, always, always suggest that as an investor you should disclose every detail of your short sale transactions to the lender, or risk legal trouble. We aren’t lawyers, but you can never hurt yourself (legally) by providing too much information. We talked about it in this article on the root cause of the foreclosure crisis, in this article on about deficiency judgments, when we discussed 2nd lienholder fraud, and even how important disclosure is when assembling your short sale package.Let’s read the direct quote from Freddie Mac: What is short payoff fraud?According to a member of Freddie Mac’s Fraud Investigation Unit, a slight variation of our general definition of mortgage fraud also defines short payoff fraud – “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.” Misrepresentations in these schemes may include the buyer of the short payoff property, a subsequent transaction at a higher price, and/or the selling borrower’s hardship reason used to qualify for the short payoff. In many instances, the short payoff fraud will involve a “facilitator,” engaged by either the listing agent or the selling borrower, to assist with negotiating the transaction.I think it’s pretty clear what they are saying. Hiding information or deliberately omitting information to the lender that may impact the lender’s decision is fraudulent. I’m not sure what the big surprise is here. This has always been the case – recent short sale fraud cases in Connecticut prove it.More detail:There are many variations of short payoff fraud. The example below is just one way this type of mortgage fraud can occur. A seller (delinquent borrower) owes $100,000 on a property that is worth $80,000. The short payoff facilitator negotiates with the bank to accept a $70,000 offer to purchase the property. In several instances, Freddie Mac has seen that this offer will be made directly by the facilitator or through an entity under his/her control. The lender/investor accepts the offer for $70,000. The facilitator neglects to disclose to the lender/investor that there is an outstanding offer between the facilitator and a second end-buyer for $95,000. Both transactions close on the same day with the net difference being pocketed by the facilitator and increasing the lender/investor’s net losses. At first glance, this may look like a legitimate short payoff. However, in this example, the fraud is the failure to disclose the second, higher offer. The facilitator is willfully withholding important information the same way a scam artist would, and the lender does not realize they are walking into a premeditated short payoff fraud scheme. Because the facilitator is deliberately withholding the higher offer, Freddie Mac also experiences a larger than necessary loss on this sale.Solution: Disclose your B-C transaction. Here’s the thing, and this is what investors need to be good at doing: making the case to the bank to accept your offer. Perhaps you were able to negotiate higher than market value. In the above case, if you as an investor can find someone to pay $95k on a property that is worth $80k, good luck!Most banks already require you to disclose anyway in a short sale transaction. Again, we aren’t a legal blog, so please contact a lawyer if you want legal advise, but you should be disclosing as much as possible in your transactions.An alternative solution is also to keep the property to fulfill seasoning requirements, then sell it. This can be done with hard money loans, but make sure you include carrying costs when calculating what profits you might be able to expect at the conclusion of a deal.More from the Freddie Mac article discussing what they consider to be “red flags”: Short Payoff Fraud Prevention Red FlagsRemain alert to the following flags, which may suggest short payoff fraud: Sudden borrower default, with no prior delinquency history, and the borrower cannot adequately explain the sudden default. The borrower is current on all other obligations. The borrower’s financial information indicates conflicting spending, saving, and credit patterns that do not fit a delinquency profile. The buyer of the property is an entity. The purchase contract has an option clause to resell the property. The first three red flags are more indicative to me of someone looking to “strategic default”, not short sell the property. Lenders should be doing their due diligence anyway when someone requests a short sale to validate the hardship scenario is legit.Similarly with the remaining two bullets: a buyer may very well be an entity and option contracts still exist. There is nothing illegal about using one. Lenders should again be doing their due diligence on these documents when in the short sale offer period. Assuming the information on those forms is truthful, the investor has nothing to worry about here.Finally, these are Freddie Mac’s suggested prevention / mitigation tactics: Short Payoff Fraud PreventionThe following protective measures are recommended in order to detect and mitigate the severity of short payoff fraud: Review all short payoff documentation carefully, including the sale contract. This helps determine if there is an option clause to resell the property at a higher price without notifying the lender. Draft a short payoff arm’s-length affidavit/disclosure notice for all parties involved in the short payoff to help avoid any hidden contracts, or side agreements. The parties involved should be, but are not limited to: the buyer, seller, listing agent, selling agent, short payoff negotiator(s)/facilitator(s), and closing agent. Solicit information from your borrower. Inquire if the borrower is aware of any other parties involved with the short payoff other than real estate professionals. Is there a short payoff negotiator/facilitator involved? Is the borrower aware of any other purchase contracts on the property? Require an executed and signed IRS Form 4506-T, Request for Transcript of Tax Return,from each borrower and process the form to determine if the borrower’s qualifying income is accurate. Order an interior Broker Price Opinion (BPO) and review all other BPOs that have been ordered on the property (drive-bys and full interiors) to establish a high/low value variance. The BPOs should include a past and present Multiple Listing Service (MLS) listing history, as this will determine if the property was relisted in MLS while the short payoff is being processed. Review the Freddie Mac Exclusionary List to see if the parties to the short payoff are on the list. Seller/Servicers can access the Exclusionary List via the selling system, MIDANET®, MultiSuite®, and Loan Prospector®. Immediately notify Freddie Mac if you are aware of a second purchase contract for a higher price Again, do you see anything here that all lenders (not just GSE’s like Fannie Mae and Freddie Mac) aren’t already doing? Seriously – a suggested step for the lenders to take is to “review all documentation, including the sales contract”?Post your thoughts in the comments! Do you think this will impact your investing business? What are your thoughts on short sale disclosure?Looking for Short Sale Software? Visit Short Sale Artisan today!