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Why Lenders Are Leery
Of Short Sales
This Foreclosure Alternative
Helps Strapped Homeowners,
But It's Not Easy to Pull Off
By RUTH SIMON and JAMES R. HAGERTY
April 17, 2008; Page D1
As more people fall behind on their mortgages, lenders have been slow to take advantage of a longstanding alternative to foreclosure -- a so-called short sale.

At first glance, a short sale might seem like a win-win for everyone involved. In such an arrangement, the borrower sells the home for less than the amount owed, with the lender forgiving the difference. The sale releases borrowers from their obligations. For mortgage holders, it can be less costly than foreclosing -- and could provide protection against future price drops. For buyers, it can be a chance to buy a home at an attractive price.

SELLING SHORT
Short sales -- in which a homeowner sells a property for less than its loan value -- are tricky to pull off:
• It can take weeks or months to get mortgage companies to respond to an offer.
• Mortgage servicers may balk at the purchase price.
• Homeowners may have more than one loan on the property, slowing the process.
Short sales -- which were rare when the housing market was booming -- can also be a good way for lenders and investors to minimize losses. They typically result in losses of 19% of the loan amount, compared with an average loss of 40% for homes that are sold after foreclosure, according to a recent analysis by Clayton Holdings Inc., which tracks more than $500 billion in mortgage loans monthly for investors. The costs of foreclosure can include not only legal fees, but also taxes, insurance and the expense of maintaining the home until the property is sold and repairing any property damage.

As the housing market continues to weaken, the number of short sales is edging upward. Short sales currently account for about 18% of home sales, according to the National Association of Realtors. But it can be extremely difficult to get these deals completed. Unlike a traditional real-estate sale, a short sale requires the approval of not only the buyer and the seller, but also the mortgage-servicing company. In many cases, loans have been packaged into securities -- which means that the mortgage servicer must consider the interests of the investors who own the loans.

Deals can fall apart because the mortgage company rejects the price that has been agreed upon by the buyer and seller. Long delays in getting an answer from the mortgage servicer are another obstacle.

The process can be so frustrating that some real-estate agents and home buyers have decided that a short sale isn't worth the effort. Shari Adams, a paralegal, bought a foreclosed three-bedroom house in Stuart , Fla. , after she tried twice to buy a home being sold in a short sale. One deal fell through when the mortgage servicer turned down her offer after six weeks and didn't make a counteroffer. Another deal collapsed because it wasn't clear that the seller was truly facing a financial hardship.

"I basically started to run away from any home listed as a short sale," Ms. Adams says.
Low Success Rate
The success rate for short-sale offers is low, real-estate agents say. Molly Kay Hamrick, president of Coldwell Banker Premier Realty in Las Vegas , estimates that 20% of short-sale offers in the area lead to completed sales, compared with 85% for more traditional sales. Redfin, an online real-estate brokerage based in Seattle , says it represented buyers on 65 short-sale offers in the first quarter but expects only two or three to result in a completed sale.

Because so many deals fall through, Jean Manner Schwimmer of Coldwell Banker Gay Dales in Salinas , Calif. , advises buyers making an offer on a short sale to put a clause in their contract that says the deposit can't be cashed until it is clear that the sale has been approved by the mortgage company and the contract has been signed.

Many borrowers walk away in frustration because it takes so long to get a response from the mortgage company to their offer. Servicers take an average of 4½ weeks to provide an answer on a potential short sale, according to a recent survey of real-estate agents by Campbell Communications, with some taking two months or more to respond. By contrast, it takes an average of less than two weeks to get a response to an offer for a property that has been foreclosed on, the survey found.

"To make the process work, you have to have a buyer who just wants that property and is willing to wait three to four months," says Beth Butler, chief operating officer of EWM Realtors, based in Miami .

Alicia and Greg Green accepted a short-sale offer in December for a home in Los Angeles they had purchased as an investment. But the deal didn't close until late March because of delays in getting an answer from the mortgage servicer, Option One Mortgage Corp. At least two offers at higher prices fell through because of delays, says Bill Etchegaray, the couple's real-estate agent.

"Luckily, we didn't lose the buyer," says Ms. Green. "I thought we would because the process took so long." The couple sold the home for $299,000, well below the $375,000 mortgage balance. They fell behind on their payments when the construction business Mr. Green owned went under. A spokeswoman for Option One pointed to the complexities of arranging short sales and said the company is pleased that the sale was successful.

Coming up with what everyone agrees is a fair price can be tricky in a soft market. "Servicers are finding that people try to low-ball the sales price knowing that the property is distressed," says Vicki Vidal, a senior director with the Mortgage Bankers Association.

Missed Opportunities
But with home prices falling in many markets, a rejected short-sale offer may wind up as a missed opportunity. Donald Schriver, owner of Assist-2-Sell Good Sense Realty in suburban Phoenix , says a homeowner he was helping late last year was offered $190,000 for his house in a short sale but was unable to win approval from his mortgage company. The borrower later decided to abandon the four-bedroom house, which was built in 2005. The house is now in foreclosure, with an auction scheduled for June. Prices in the area have continued to fall, says Mr. Schriver, who believes that the most the home would now fetch is $180,000.

A spokesman for Wells Fargo & Co., which services the loan, said the company "made several unsuccessful attempts to connect with the customer" and didn't turn down an offer for a short sale.

Some mortgage-servicing companies are tightening up on short sales because they worry borrowers are rushing into these arrangements when there are better alternatives. In March, Ocwen Financial Corp., based in West Palm Beach , Fla. , told its customers it would consider a short sale only after it had talked directly to the borrowers and determined there are no alternatives for keeping them in the home.

"We are concerned that some of our customers are not given all the facts," says William Rinehart, the company's chief risk officer. "In some cases, it's represented to them that a short sale is the only solution to the problem they are in."

Part of the problem may be that many mortgage servicers were ill-prepared for the spike in bad loans. As delinquencies have climbed, they have had to scramble to add staff. Mortgage companies say they prefer other means to help borrowers, such as a repayment plan or loan modification.

Clearing Hurdles
Gathering all the information needed to evaluate a short-sale offer can take time, says Patrick Carey, an executive vice president with Wells Fargo. The loan servicer must first determine whether the homeowner really can't continue meeting the loan payments, then get an appraisal or broker's opinion of the home's value.

Mortgage servicers also try to ensure that the proposed sale is an "arm's length" transaction between two parties rather than, say, a sale to a relative on sweet terms. They must also determine whether the buyer has sufficient funds or the ability to get a loan. If all those hurdles are cleared, the servicer may still need to get approval from the investor that owns the loan and provide an analysis showing that the investor will be better off with a short sale than with another solution.

There are additional complications if the borrower has a mortgage and a home-equity loan. In that case, both parties must approve the deal -- which is a challenge when the sales price may not even be enough to cover the mortgage balance.

To minimize delays, Mr. Carey suggests that homeowners contemplating a short sale immediately call the loan servicer to get the approval process started, rather than wait for an offer.

There are some signs that the process is getting smoother. In recent weeks, some mortgage companies have begun to approve short sales for borrowers who can show financial distress but haven't yet stopped making monthly payments, says Dan Elsea, president of brokerage services for Real Estate One in the Detroit area. Until recently, servicers wouldn't even consider a short sale unless a borrower was at least 60 days late.

Fannie Mae and Freddie Mac, which own or guarantee nearly half of all outstanding U.S. mortgages, both say they are trying to streamline the short-sale process. Fannie Mae says that it plans to introduce a policy in the next few months under which real-estate brokers would be given an advance indication of the approximate minimum price that would be acceptable in a short sale, a move designed to quickly weed out offers that are too low.

Freddie Mac says it has already given its top servicers more flexibility to accept short sales for homes backed by loans it guarantees or owns. Lehman Brothers Holdings Inc., another issuer of mortgage-backed securities, also is offering incentives in some cases for servicers to arrange short sales or loan modifications.

Mortgage Fraud

Recognizing the Signs

Financial crimes are one of the fastest growing areas of criminal activity in the United States and one of the fastest growing areas of financial crimes is mortgage fraud. Fraud involves two parties: one makes a false statement of fact material to the business involved and the other party relies on that statement to their detriment. In mortgage fraud false or inaccurate information in connection with a mortgage application is provided and that information causes a lender or another in the chain of approving and funding that loan to make the loan or to make the loan on terms and conditions different than if the true facts were known.

Mortgage fraud includes a whole category of illegal business dealings. The different schemes that may be used include, but are certainly not limited to, property flipping, equity skimming, application fraud, credit or income misrepresentation or asset and down payment misrepresentation. Mortgage industry professionals and law enforcement break these different schemes into two groups.

There is “Fraud for Housing” in which a borrower will knowingly provide false or at least inaccurate information regarding his or her qualification for the loan. This might be something as innocent sounding as fudging a little on their income levels or employment in order to qualify for the loan or for better terms on a loan.

Although we would like to see everyone be able to obtain the American Dream of homeownership, real estate agents must be careful when counseling purchasers to avoid any suggestion that enhancing certain facts may assist a buyer in qualifying for the necessary mortgage. The desire to be helpful can not override good sense and honesty. The REALTORS^Ò Code of Ethics requires members to treat all parties to the transaction honestly, including those providing the financing for the purchase.

There is also “Fraud for Profit” which is sometimes referred to as “industry insider fraud” because it typically requires at least the cooperation, if not the participation, of an appraiser, real estate broker, mortgage broker or other real estate professional. Such cooperation or participation does not always require any action on the part of the real estate professional. It can be implicit through the real estate professional’s failure to disclose or correct a representation made by someone else which the professional knows to be false.

The consequences for the housing market differ only as to degree. The latter group causes far more in losses to the mortgage industry and ultimately the public because the people involved are not trying to stay in the property and never intended to make the payments required by the mortgage. Often their schemes will involve multiple properties and parties. They are motivated to commit mortgage fraud solely by the money that can be taken from a property. When they have done that or the threat of being caught increases they will often disappear. Individuals who provide false information to the lender to help secure their own housing lack the same kind of bad motivation and usually intend to make the payments to stay in the housing. But if they default on the loan because they really were not qualified, the community is still left with foreclosed housing and the individuals with damaged credit and credibility.

Mortgage fraud is accomplished through the use of false documents, identity theft, straw buyers, and sometimes the witting or unwitting assistance of real estate professionals. To protect themselves and their clients, real estate agents must be able to distinguish between legal and illegal mortgage practices. There are a number of different ways in which the real estate agent may inadvertently become involved in these schemes or involve their seller clients. Agents may be asked to interfere in the appraisal process, alter or not include parts of the purchase agreement that is provided to the lender or title company, intercept verifications of income or employment history or help out by hand carrying verifications provided by the buyers or others working with the buyer. Any of these activities could be a part of a mortgage fraud scheme.

Some common examples of mortgage fraud as described by the FBI include:

Property Flipping - Property is purchased, falsely appraised at a higher value, and then quickly sold. What makes property flipping illegal is that the appraisal information is fraudulent. The schemes typically involve one or more of the following: fraudulent appraisals, doctored loan documentation, inflating buyer income, etc. Kickbacks to buyers, investors, property/loan brokers, appraisers, title company employees are common in this scheme. A home worth $200,000 may be appraised for $400,000 or higher in this type of scheme.

Silent Second - The buyer of a property borrows the down payment from the seller through the issuance of a non-disclosed second mortgage. The primary lender believes the borrower has invested his own money in the down payment, when in fact, it is borrowed. The second mortgage is usually not recorded to further conceal its status from the primary lender.

Nominee Loans/Straw Buyers - The identity of the borrower is concealed through the use of a nominee who allows the borrower to use the nominee's name and credit history to apply for a loan.

Fictitious/Stolen Identity - A fictitious/stolen identity may be used on the loan application. The applicant may be involved in an identity theft scheme: the applicant's name, personal identifying information and credit history are used without the true person's knowledge.

Inflated Appraisals - An appraiser acts in collusion with a borrower and provides a misleading appraisal report to the lender. The report inaccurately states an inflated property value.

Equity Skimming - An investor may use a straw buyer, false income documents, and false credit reports, to obtain a mortgage loan in the straw buyer's name. Subsequent to closing, the straw buyer signs the property over to the investor in a quit claim deed which relinquishes all rights to the property and provides no guaranty to title. The investor does not make any mortgage payments and rents the property until foreclosure takes place several months later.

As is demonstrated in each of the foregoing descriptions, a key element of the problem is the imbalance of information. One side, normally the borrower or someone working with the buyer, conceals information from or affirmatively misleads the lender. Anytime an agent suspects this may be the case, further investigation is warranted to rule out any involvement by the agent or their unwitting client in a fraudulent transaction. There are several clues which may alert the agent that there may be a problem.

One of the most important documents in detecting fraud is the original sales agreement and any addenda to that agreement. It is the document which the real estate agent is most likely to be involved in preparing. Thus, care must be exercised in preserving its accuracy. Things to be sure of:

· The property is clearly identified

· All parties to the transaction are identified and have executed the agreement

· The signatures are legible or properly identified

· All riders and addendums are attached

· There are no blanks or inconsistent information in the purchase and sales agreement

· It accurately reflects the consideration to be paid by the buyer for the property

Other possible red flags:

· Significant sales price adjustments that are not supported by comparable market data possibly accompanied by request that list price in MLS be altered to reflect appraised value.

· Required use of a particular appraiser

· Down payment assistance programs that charge excessive fees or that attempt to place restrictions on how their participation is reported in contract documentation, including the HUD 1

· Large seller contributions, possibly in the form of provisions for large decorator or improvement allowances

· Mortgage brokers who refer pre-qualified buyers to agents

· Statement that the buyer will occupy the property is questionable. For example, the buyer is retaining old property or there is unrealistic commute to the buyer employment

· Buyer has very limited credit history and existing history is with high rate consumer finance companies

· Credit history indicates the repayment of a prior obligation did not include any interest payments

· Unrealistic income for occupation

· Recent drastic increase in income due to a raise or a new job

· Sales contract, appraisal and title work disagree with respect to seller’s name and appraisal shows property or comps previously sold in past year.

If these warning signs are present in your transaction, bring the situation to the attention of your broker. While fraud isn’t involved every time one of these warning signs appear, the few minutes it will take to decide between innocent and fraudulent can save you and your broker time, money and maybe even your license, and reporting fraud will protect the communities in which you do business.

Mortgage fraud is more than a just a possibility for real estate professionals. Read the following fraud profile which describes one broker’s experience and lesson.

An agent was asked by a friend to help in the acquisition of a distressed property. This friend was in the mortgage brokerage business with her husband. The agent successfully assisted her friend in the purchase. Unbeknownst to the agent, the buyers arranged a simultaneous closing for the same property to another buyer for double the original purchase price. The issues of fraud were as follows:

1. The second buyer was a straw buyer whose loan qualifications were “enhanced”.

2. A fraudulent appraisal was obtained to substantiate the inflated second sale price to the lender funding the loan.

3. The simultaneous closing was doctored to allow the high LTV loan on the second transaction to close first in order to fund and close the first transaction.

4. Participation of the escrow closer is not documented but the closing sequence certainly should have raised questions.

5. Not surprisingly, the straw buyer did not perform on the loan and the lender took a large loss.

Outcome: The mortgage broker served Federal prison time. Unfortunately, his name has come up again following his release from prison. The agent was not prosecuted only because there was no evidence that she had any knowledge of the fraudulent second sale to the straw buyer.

Lesson learned: If the agent becomes aware of a short-term flip of a property for a lot more money, without justification for a higher value, the agent should be alerted that he or she could be implicated in a loan fraud investigation and take appropriate steps of self-defense.

Have your own story you would like to share or want to learn more about mortgage fraud? Go to http://www.realtor.org/letterlw.nsf/1006mortgagefraud

Prepared by the Risk Management Committee of the National Association of REALTORS®

Permission to reproduce and distribute the text is granted to all members and member boards.