Homeowners and agents: Beware the consequence of SHORT SALE FRAUD

FIRM COMMENTARY: 

As the number of homeowners considering short sales increase, so does the number of incidents of SHORT SALE FRAUD. As an agent, if you regularly take “pocket listings” or if you facilitate acceptance of a preferred offer too quickly, you may be unknowingly engaged in short sale fraud which can harm your SELLER and expose you to liability. 

While it’s true that short sale deficiencies are generally forgiven in California under Civil Code 580, there is a “fraud exception”.  If you knowingly or unknowingly engage in a form of short sale fraud, it may result in your Seller owing the full deficiency and thereafter suing you.  Of course, even if a loan servicer forgives a seller for the deficiency, the seller may owe taxes on the amount of debt that is forgiven notwithstanding the Mortgage Forgiveness Act. DO NOT ASSUME OR REPRESENT THERE IS NO TAX LIABILITY ARISING FROM A SHORT SALE. Contact this firm for a legal opinion and protect yourself from potential liability arising from the unauthorized practice of law.

Short sale fraud schemes come in different guises, but a few are more common than others. Short sale Seller’s and agents should be on the lookout for the three scams discussed in-depth here.

Scam #1: “Undisclosed Payments”

Red Flags: Payments made “outside of escrow” or “off the settlement statement.”

Perpetrators: Sellers, junior lien holders, real estate agents, short sale negotiators.

Victims: Sellers, buyers, lenders.

Example of the scam: Loan Servicers approve short sales to avoid foreclosure and minimize their investors’ losses. As a condition of approval, Servicers often do one or more of the following:

• Reduce commissions to real estate brokers and agents.

• Require that sellers receive no or a limited financial benefit from the sale.

• Reduce or even disapprove payments to other parties involved in the short sale (e.g., short sale negotiators, attorneys, etc.).

Loan Servicers will also cap payments to junior lien holders. If there is more than one loan on the property, the short sale will not go through without the release of the junior liens. In order to get this release, the primary lender will allow some nominal payment to the junior lenders but will set a cap on these payments.  Under HAFA, the maximum payout is increased to $8,500.00.

Those parties receiving reduced or capped payments are often unhappy with such reductions and caps. So as to take advantage of highly motivated buyers or sellers, they request payments “off the settlement statement” or “outside of escrow”.  Parties involved in a short sale are often tempted to make an undisclosed payment just to get the deal done. But by doing so, however, they would most likely be parties to loan fraud.

All payments made as part of a short sale transaction should be disclosed to the loan servicer approving the short sale. According to Fannie Mae, short sale fraud occurs when someone deliberately misrepresents a fact or omits a fact so as to induce a lender, investor, or insurer to agree to a short sale that it would not have approved if it had known the truth. How do you know whether a certain payment would have affected a lender’s decision to approve a short sale? Assume that you don’t and to be safe…DISCLOSE.

Short Sale Scam #2: “Flopping”

Red Flags: Double escrows; buyer is an LLC or a fictitious entity or purchasing under a power of attorney; purchase agreement gives buyer the option to resell property.

Perpetrators: Real estate agents, buyers.

Victims: Sellers, lenders.

Example of the scam: “Flopping” occurs when a short sale is approved based on a misrepresentation of the value of the property. The fraudster is the buyer purchasing the property from the short sale seller or the seller’s real estate agent is the buyer. The fraudster presents a low ball offer to purchase the property to the lender along with an artificially low valuation of the property, in order to trick the loan servicer into the belief that the property is worth less than fair market value.

Pocket Listings are often used in this scam.  Any higher offers from bona fide buyers are withheld from the loan servicer, since the loan servicer would most likely reject the low offer if it knew that higher offers existed. Once the loan servicer approves the short sale at the low price, the fraudster contacts the bona fide buyer or markets the property at its fair market value.

Without the loan servicer’s knowledge, a second escrow between the fraudster (now the seller) and a bona fide buyer is then opened to close simultaneously with the first purchase, or soon afterward. The fraudster buys low, sells high, and keeps the spread between the two sale prices.

Sellers can also be hurt by flopping, because lenders may hold sellers responsible for the deficiency of the amount of the difference between what the seller owed and the sale price. While it’s true that short sale deficiencies are generally forgiven in California, there is a fraud exception.  Of course, even if a lender forgives a seller for the deficiency, the seller may owe taxes on the amount of debt that is forgiven notwithstanding the Mortgage Forgiveness Act. (To learn more about income tax liability in short sales, contact this office-do not assume there will be no income tax liability from a short sale!)

Short Sale Scam #3: Predatory Short Sale Negotiators

Red Flags: Upfront fees; fees required to be paid outside of escrow; negotiator is not licensed.

Perpetrators: Short sale negotiators, real estate agents.

Victims: Sellers, buyers.

 

Example of the scam: Sellers considering short sales are particularly vulnerable to predators and con artists you will take advantage of the stressful situations. These scammers, calling themselves short sale negotiators (or short sale processors, short sale coordinators, short sale expeditors, debt negotiators, debt resolution experts, loss mitigation practitioners, or foreclosure rescue negotiators) guarantee results for a flat fee or a percentage of the sale price. Oftentimes, the short sale negotiator takes the fee and does nothing or little in return.

California requires short sale negotiators to be licensed by the appropriate state agency (the agency responsible for licensing and regulating attorneys and real estate agents). If you are considering hiring a short sale negotiator, you should contact your State Bar or Department of Real Estate to find out whether short sale negotiators need to be licensed and, if so, whether the short sale negotiator you are planning on hiring is indeed licensed.

In California, it is illegal for short sale negotiators to collect fees in advance of providing services, unless certain stringent requirements are met. You should review the Foreclosure Consultant Act which provides for criminal as well as a triple damage recovery against potential scammers that are not properly licensed to represent a homeowner after the Notice of Default is filed.

Before hiring a short sale negotiator, do your due diligence. Read documents carefully before signing. Ask questions. Ask for and contact references. Seek the advice of this law office for guidance. Remember, if it sounds too good to be true, it probably is.