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Second hand outs: a new form of short sale fraud is emerging: second lien holders demanding kickbacks.

A FEW YEARS AGO, the reaction from struggling homeowners, buyers and real estate professionals to the term "short sale" was typically one of confusion. While still a generally misunderstood concept, short sales have been gaining traction as more and more deals are being completed. However, the way in which they are conducted is becoming increasingly important to appraisers.

According to The Dictionary of Real Estate Appraisal, 5th ed., a short sale is "a sale of real property in which the proceeds from the sale fall short of the balance owed on a loan secured by the property. Lenders may agree to a short sale to avoid lengthy and costly foreclosure proceedings, and borrowers who cannot meet their mortgage obligations may agree to a short sale to satisfy their debt."

A short sale is a voluntary process on the part of the lenders and is something the property owner must negotiate. In some cases, the difference is forgiven by the lender, and in others, the homeowner must make arrangements to settle the remainder of the debt.

For years, real estate agents have bemoaned the difficulty of conducting a short sale, which typically involves multiple parties. Securing all required approvals for such a transaction can take several months, so it was not uncommon for deals to fall apart as frustrated potential buyers walked away. However, lenders are becoming more receptive to short sales not only because they allow them to skip the expenses and time typically associated with foreclosures, but also because of new federal incentives spurred by the collapse of the housing market.

For homeowners, a short sale provides a more dignified transaction than a foreclosure, allowing them to return to homeownership sooner. Fannie Mae, for instance, requires at least a five-year wait after a foreclosure but only two years after a short sale. Short sales also are better for the neighborhood because the home stays occupied instead of becoming a vacant foreclosure that may attract crime.

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EMERGING FRAUD

While selling a home through a short sale is legal, all payments to all parties involved in the transaction must be disclosed on the Department of Housing and Urban Development's HUD-1 settlement statement., because second lien holders frequently receive a fraction of the total amount owed to them from a short-sale transaction, some are beginning to demand a payment from the seller, buyer or agent in an attempt to recoup losses in exchange for releasing their claim.

Second lien holders are acutely aware that they will not receive any compensation if a property goes into foreclosure. However, they know that short-sale sellers are in financial duress and are attempting to salvage their credit, which places them in a vulnerable position. Real estate agents have reported that several major lenders, including Citi Mortgage, JP Morgan Chase, Bank of America and other large banks have requested similar payoffs before signing off on a second lien.

While in and of itself that practice is not illegal, the payment must be documented as part of the sale; a kickback cash payment delivered at closing that is not documented in the HUD-1 settlement statement is clearly a violation of the Real Estate Settlement Procedures Act. If payments are made to the second lien holder without notice to the primary lien holder, then the agent, as well as the seller, may be exposed to liability or fraud.

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According to banking officials quoted in various media outlets, that is exactly what is happening--in an increasing number of situations. To add to the mix, unlicensed third-party negotiators have been preying on struggling homeowners, demanding up-front fees to orchestrate short sales that often involve kickback deals to second lien holders in order to quickly expedite the transaction. Often these negotiators want to take advantage of the process by jumping in and trying to get a slice of the home's equity.

"Third-party negotiators are preying on the very people (who) have already been victimized by bad appraisals, large loans and loans with undisclosed issues, like hidden interest-rate hikes," says Richard Hagar, SRA, who teaches appraisal and mortgage-fraud classes. "If there are second and third liens, the negotiators charge additional fees, due to the 'need' to negotiate with more parties. Then when (they) do negotiate, they often provide bad, if not downright illegal, advice."

CURBING SECOND LIEN HOLDER FRAUD

Lack of knowledge regarding the short-sale process has compounded the issue surrounding second lien mortgage fraud, with many real estate professionals and lenders unaware of what exactly is legal. To help protect consumers and real estate professionals from this practice, various local and federal government agencies have been cracking down on mortgage fraud and deception through increased law enforcement and consumer outreach.

"How could (second lien fraud), or any fraud for that matter, be curbed? Education and penalties for the people who don't learn," Hagar says.

In an attempt to better enforce those penalties, the number of FBI agents investigating mortgage fraud more than doubled from 2006 to 2008. Furthermore, the U.S. Treasury's Financial Crimes Enforcement Network has continued to track suspicious activity reports. Suspicious activity reports on suspected mortgage-fraud cases increased by less than 1 percent during the first six months of 2009 but remain at historically high levels, according to a Jan. 22 FinCEN release. The slight increase--from 32,660 reports in the first six months of 2008 to 32,926 reports for the same time period of 2009--is in sharp contrast to the 39.1 percent surge recorded during the same period from 2007 to 2008, which shows that while the problem has not gotten worse, it has not subsided.

In the latest FinCEN data, borrowers were the most frequently cited subjects of mortgage-loan fraud during the first six months of 2009, accounting for 25,960 suspicious activity reports, FinCEN reported. Brokers were the second most cited subjects at 7,601 reports. Appraisers were cited in 3,426 suspicious activity reports. Use of a false statement was cited as the most frequent activity associated with mortgage-loan fraud, with 9,017 instances. By comparison, the next two most frequent--identity theft and consumer-loan fraud--were mentioned in 980 and 296 suspicious activity reports, respectively.

In addition to FinCEN, the Federal Trade Commission is aggressively investigating mortgage-relief scams through increased law enforcement and consumer outreach, and it is coordinating efforts with federal, state and nonprofit partners. In addition to federal laws and agencies, states across the country are increasing efforts as well.

FinCEN and the FTC, along with the Treasury Department, Department of Justice, and Department of Housing and Urban Development, say they are committed to curbing mortgage fraud. Efforts include alerting financial institutions to emerging schemes, stepping up enforcement actions and educating consumers on how to avoid becoming a victim of a loan-modification or foreclosure-rescue scam.

James Sobiesczyk is a communications specialist at the Appraisal Institute and a staff writer for Valuation and Appraiser News Online. He can be reached at jsobiesczyk@appraisalinstitute.org.

For a list of Web sites where appraisers can report fraudulent activity, see page 29

APPRAISAL IMPACT

The recent surge in the number of short sales has presented challenges for appraisers and other professionals who depend on Multiple Listing Service data for an accurate picture of the current housing market. When second lien kickbacks aren't included in the HUD-1 report, the resulting incomplete picture has a negative impact on real estate values.

"When there is money paid outside of closing that is not disclosed on the HUD-1, a misleading sales price is entered into the county database, appropriate transfer taxes are unpaid, and the sales price is shown below actual (price)," says Richard Hagar, SRA. "Now with the sub-sale price in the system, agents and appraisers are misled concerning the sale, which makes BPOs and appraisals inaccurate."

By James Sobiesczyk, Appraisal Institute communications specialist
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Author:Sobiesczyk, James
Publication:Valuation Insights & Perspectives
Date:Jan 1, 2010
Words:1299
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