By Robert Freedman, Senior Editor, REALTOR® Magazine
A few months ago we heard from real estate practitioners about a short-sale contract addendum that lenders were requiring of borrowers to curb fraud, so we talked with David Sunlin, Bank of America senior vice president and operations executive for short sales, to learn more about his company’s version of that form. He said it had been incorporated into the process in part because of a Freddie Mac policy requiring borrowers to vouch that their deal is an arm’s-length one. “They came to us and said, ‘We, as an investor, require you to do this,’ said Sunlin. “And then we looked at it and thought it was a good practice, so we extended it to our entire portfolio that we service.”
As a follow-up to that conversation, we spoke with Kathleen Cooke, fraud investigation manager at Freddie Mac, in mid-June, and she said her company’s requirement was simply putting into formal practice what the industry had informally required all along: that parties to a short-sale transaction show there’s no collusion between them.
Cooke said fraud continues to be an issue with short sales, mainly flipping arrangements, but other types of fraud are cropping up, too. The impact of her company’s anti-collusion affidavit is preventative: some parties that are thinking of colluding aren’t, because the affidavit takes away the legal gray area: Once you vouch for the fact that the deal’s at arm’s length, you have nothing to hide behind if you’re shown to be colluding. Cooke thinks the affidavit is succeeding in combating fraud.
Here are the highlights of our conversation with her:
REALTOR® Magazine: What kinds of short-sale fraud are you seeing?
Kathleen Cooke: We’re seeing flipping going on, the same day or shortly thereafter, that the property is bought. These deals are for tens of thousands of dollars more [than the purchase price], in some instances $80,000 more. And the lender and Freddie Mac were unaware of the higher offer. Typically what we see there is a straw buyer, usually a family member or a friend, who purchases the property and then sells it back to the borrower. We have several cases open throughout the country, so it’s not concentrated in any one area. There are real estate companies out there that market these services and secure straw buyers for the sellers.
RM: Let’s say I’m a friend of the owner, who’s selling his house as a short sale. I buy it, and sell it back to the owner. Is that illegal?
KC: From our perspective, a seller cannot profit from a short sale. And that includes profiting by shrinking the principal through a pre-arranged deal.
RM: What are other types of fraud you’re seeing?
KC: When we or a servicer of a Freddie Mac loan is approached for a short sale, one of the first things we do is order a broker price opinion (BPO) from one of our vendors. We want an interior and exterior inspection to value the collateral. What we’ve been finding is that some of the BPO agents are compromised. They’re being manipulated by the facilitator [short-sale negotiator], who will either offer the BPO agent a bribe or their own comparables and compel him to use them, or they’ll fabricate issues with the home, repairs that are needed, and inflate the repair costs. Their intention is to depress the value. And then they flip it at a higher amount, the true market value.
Some other things we’re seeing are fees paid out on the seller side. These are fees disguised as marketing or administration fees or seller concessions that are paid directly to the short sale facilitator. In the realty world a seller concession is basically a payment to a buyer who might need assistance with closing costs. But what we’re seeing is that these marketing or administration fees are going to the buyer, so they’re credited on the buyer side and then immediately paid out on the buyer side, on the second page of the HUD-1 form, to the facilitator. And these are not insignificant fees. They range from 3 percent to 9 percent of the sales price. So, in high market areas you can certainly clean up.
Another type of fraud we’re seeing are second lien payments being made outside of closing. They’re not going on the HUD-1. This one case we had was actually the lender’s short sale negotiator. This lender had both the first and the second. We received a tip on our fraud hotline from a buyer and his real estate agent, who was working with the negotiator. The original purchase offer from the buyer was $100,000, and we allot a $3,000 payment to come out of the proceeds to go to the second on these deals to release the lien. But the second lien in this case was also owned by the servicer of the first mortgage and they wouldn’t settle for less than a grand total of $25,000. So with the $3,000 that we would have allotted through the proceeds, they wanted $25,000, so the negotiator instructed the real estate agent to reduce the sales contact to $77,000 and pay $22,000 outside of closing to the second. So neither the agent nor his buyer were comfortable with that and called the hotline. It’s all about transparency and disclosure.
RM: How does the addendum you developed tackle the transparency and disclosure issue?
KC: Effective in September 2010, Freddie Mac required our servicers to use an arm’s-length affidavit, a short sale affidavit. We don’t provide a form. Our servicers create their own form, but it has to contain specific elements. The parties have to be unrelated. It has to be a true arm’s length transaction, unaffiliated by family, marriage, or c commercial enterprise. There can’t be agreements or contracts between the parties that the borrower will remain in the property as a tenant or later obtain title. The borrower, seller, and purchaser can’t receive funds or commissions from the sale. And there are no agreements or contracts relating to the sale or subsequent sales that haven’t been disclosed. All the parties understand that the lender and Freddie Mac are relying on the statements and the affidavit as consideration for the short sale. The parties agree to indemnify the servicer and Freddie Mac for any and all loss resulting from an intentional misrepresentation or negligence made in the affidavit. So, if the buyer or the third-party facilitator knew of a subsequent deal and they signed it, there would be repercussions. And this affidavit needs to be signed by all parties to the transaction: the buyers, sellers, the listing agent, the selling agent, any third-party facilitator or negotiator that’s involved, as well as the closing agent.
RM: We’re coming up on a year since you put the affidavit in place. Are you seeing a reduction in fraud as a result?
KC: We’re catching them before they close now. That’s the major difference. Because the parties are looking at this affidavit and they’re backing up, saying, “Whoa, there’s something that we haven’t disclosed, and now we’re going to have to disclose it.” it’s going to act as a deterrent to honest people; it’s not going to act as a deterrent for people who are intent on perpetrating fraud. It makes it easier to identify the fraud. For instance, if they flipped it and we didn’t know about it, and they clearly signed the affidavit, the closing agent clearly signed it and clearly executed and closed both transactions, so it does make it much easier, because you have their signature on the affidavit. And you can tie via public records the fact that they resold it.
We’re not saying you can’t flip a property; we’re just saying we need to know about it so we can make an informed decision. Because our expectation is that the highest and best offer is presented to us as well as the full disclosure of any a-typical fees and costs. When we look at the short sale transaction, the offer amount as presented is material to our risk assessment and the ultimate decision on that short sale.
RM: The short sale contract addendums that some lenders have put into place, by some accounts to incorporate your affidavit, are acting as a deterrent to getting transactions closed, some real estate agents believe.
KC: I don’t think anything we have in our guide would act as a deterrent to legitimate short sale transactions. All we want is transparency and disclosure so we can make the best decision for us. I’ve talked to real estate agents and they’ve had no issues with what’s in the form. Now, the industry did have an informal, arms-length affidavit before our requirement. It was basically a two-paragraph deal that said it’s a true arms-length transaction and no one is walking away with funds and that the borrower can’t stay in the property. And everyone associated with the transaction had to sign it. So, this affidavit certainly isn’t new; it’s been employed for the past several years. It’s just more robust.