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!)

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.

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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

About Author

Ken Corsini

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.


    • Ken Corsini

      If the property goes into foreclosure, you won’t need to worry about arms-length affidavits. However, if the property goes REO, you can still end up with a deed restriction limiting your ability to resell within 30, 60 or 90 days and/or with price increase restrictions as well.

  1. Jarrett Camarda on

    As a Realtor, I often see a violation of this affidavit. While you should not participate in an arms-length transaction, it is wildly unethical, it is all-too-common, and an easy way out for many upside-down homeowners. While you could potentially be in hot water, the banks don’t have the time, energy or resources to police this. You likely won’t get caught, but it sets a bad example. Go buy something else and cut your losses.

      • Jarrett Camarda on

        What I meant by advising against participating in an arms-length transaction is best represented as a real-life example from some other Realtors that I know. Here’s my best shot as describing it.

        Say Bob purchased a home in a wealthy neighborhood for $2.1 million in or around 2001. Over recent years, as home prices increased, Bob kept refinancing the maximum allowed on the house every year, and eventually owed $5.2 million in mortgages and HELOC’s to fund his lavish lifestyle that he really couldn’t support with his own money. Then comes the crash, and now Bob’s house is worth $3 million. Bob gets his sister, Sue, to buy the house in a short sale for $3 million from the bank, willfully disregarding the affidavit stating that she has any prior relationship (arms-length) with Bob, the seller. Obviously she is lying to deceive the bank. Now that Sue owns the house, Bob never moved out, and may pay a small rental amount to his sister for her generosity of buying the house, but they screwed the bank.

        Now that the market has swung back up sharply, the house is worth $5.2 million again, and Sue can sell the house, and keep the equity she has in it, which she essentially screwed the bank out of, because Bob no longer has the debt, but he’s still living in the house.

        This is a true story, and a very very common one here in Beverly Hills and Los Angeles.

  2. Another potential gotcha – if you are a Realtor buying a rental for yourself (even though it isn’t quite the same as the Arms Length issue).

    I’ve had 2 occasions where Wells Fargo decided at the last minute that they wouldn’t pay the buyer’s side commission since I was the buyer. Since I count on the commission as a part of making the numbers work for me this torpedoed 1 deal just days before closing while the other was a better deal and I just dealt with it.

  3. Tracy Royce

    Great article Ken, glad you are bringing this to light. As investors we like to participate in creative win-win solutions, but the Lenders seem to want to have a hand in how creative we really can be. …So be it; they’re taking a haircut, they want provisional agreements in place. Although on one side it’s questionable how much effort they’d put into policing your actions after the sale, on the other hand, much can be avoided by just disclosing your intent.

    I had someone calling me asking advice on a short sale, planning on renting the home back to the (current) Seller of the property. I highly encouraged him to sell to someone else if he could and profit just the same, citing the ALA. Not to mention, no good deed goes unpunished, often with sellers having quite a change of emotion or reasoning once the pressure is lifted (ie a completed short sale). Keep up the good work.

  4. Ken, I’m in the process of buying my first (and likely only, I think) short sale and my question is this: does the receipt of the arms length affidavit give me any clue as to how close I might be to having my offer accepted? The house had been on the market for +/-900 days in August 2013 when we offered $6000 over the seller’s asking price (as their broker pointed out, “that’s not the bank’s asking price…” I got the sense that the broker was not exactly acting with urgency, as he continued to request documents from me for about a month, culminating in an addendum that he said was required for him to submit the offer to the bank. Since we’re purchasing the home to use as a summer house, we don’t have much urgency and in fact would prefer for the process to continue over the winter and into the spring. Since submitting the offer to the bank he’s asked for an updated mortgage commitment but this recently received arms length affidavit seems to me, inexperienced as I am, to indicate that the bank is close to accepting the offer. Not that it means they’re anywhere close to ready to close, I hope!

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