Short Sales: Fraudulent Practices

According to Nolo's Plain English Law Dictionary, a Short Sale is: The sale of a house in which the proceeds fall short of what the owner still owes on the mortgage. Short sales usually occur when the homeowner is facing foreclosure. Many lenders will agree to accept the proceeds of a short sale and forgive the rest of what is owed on the mortgage when the owner cannot make the mortgage payments. By accepting a short sale, the lender can avoid a lengthy and costly foreclosure, and the owner is able to pay off the loan for less than what is owed. While this definition obviously does not tell the whole story or the legal process issues, it is correct in a broader sense. For example, the overall intent is to avoid foreclosure and the fees attendant thereto; but, the Agreement between the borrower and the lender does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, which is known as the "deficiency." Extinquishing the remaining balance must be clearly stipulated in any acceptance. Lenders in particular have been increasingly affected by fraudulent practices on the part of various types of companies. Many state banking departments and certain federal agencies have come out with notices for lenders to be aware of schemes and scams to defraud. One of the most recent such notices comes from the California Department of Real Estate (DRE). This state agency has been consistently proactive in many areas in the fulfillment of its mission of consumer protection, advocacy, and licensing enforcement. Therefore, we are providing the DRE's recent notice, entitled "Short Sale Fraud Alert September, 2010: Update to DRE Issued Consumer and Industry Alert(s) Regarding Short Sales Fraud, and Related Issues." We think the notice is useful as a means to better understand the scope of fraudulent practices involving short sales. Also issued by the DRE is a letter to lenders from Jeff Davi, California Real Estate Commissioner, entitled "Short Sale Fraud Warning For Lenders, Servicers, GSEs, and Other Mortgage Owners and Investors (referred to collectively as "Lenders"and individually as "Lender"), and subtitled "A Time for Collaboration and Cooperation." Virtually all incidents of short sale fraud involve the knowing failure to disclose material information to the short sale lender. As a result, lenders are approving sales based on false or omitted information. _______________________________ If you have any questions about this matter, please contact Jonathan Foxx, Managing Director. _______________________________ Highlights Short Sale Flipping: one of the major and recurring schemes is short sale flipping, where real estate agents and brokers have defrauded a short sale lender with respect to the value of a property and purchase offers received, and then, in turn, resold the property for a much higher price. These types of scenarios usually involve a false appraisal or broker price opinion (BPO) that was provided by the listing broker to the short sale lender with the intent of under pricing and falsely stating the value of property. Undisclosed Addenda: in some cases there is an addendum to a purchase agreement that contains conditions of the sale and agreements made between the buyer and seller that are not submitted to short sale lenders with the original purchase contract. One type of addendum that has recently surfaced is one wherein the buyer agrees to pay for the alleged service of a short sale negotiator. Whereas the closing cost credit to the buyer is or may be eventually disclosed and approved by the short sale lender, the ultimate payment of that credit to a third party is not. These payments to short sale negotiators often are not divulged on the HUD-1 statement until after the short sale lender has approved all of the terms and the transaction has funded and closed. Non-recurring closing costs: in agreements wherein sellers are crediting buyers with so-called non-recurring closing costs. This credit is then used by the buyer to pay a fee to the short sale negotiator. Whereas the closing cost credit to the buyer is or may be eventually disclosed and approved by the short sale lender, the ultimate payment of that credit to a third party is not. These payments to short sale negotiators often are not divulged on the HUD-1 statement until after the short sale lender has approved all of the terms and the transaction has funded and closed. Marketing Properties: the DRE is investigating transactions where listing brokers are indicating in their advertisements that only offers where buyers request a non-recurring closing cost credit from the seller to pay for the short sale negotiator fee will be submitted to the short sale lender. Undisclosed monies and credits outside of escrow: occur where buyers and/or sellers are receiving undisclosed monies and credits outside of escrow. These types of disbursements might also be made possible and facilitated by the escrow company handling the transaction. Visit Library for Issuances Short Sale Fraud Warning For Lenders, Servicers, GSEs, and Other Mortgage Owners and Investors (referred to collectively as "Lenders" and individually as "Lender"), A Time for Collaboration and Cooperation, DRE California September 13, 2010 Short Sale Fraud Alert September, 2010, Update to DRE Issued Consumer and Industry Alert(s) Regarding Short Sales Fraud, and Related Issues, DRE California, September 2010 Lenders Compliance Group is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.

Fannie Mae: Clarifies Undisclosed Liabilities Policy

On August, 13, 2010, Fannie Mae clarified certain aspects of its Loan Quality Initiative requirements stated in its March 2, 2010 Announcement (SEL-2010-01).

In the March update, Fannie "required lenders to determine that all debts of the borrower incurred or closed up to and concurrent with the closing of the subject mortgage are disclosed on the final loan application and included in the qualification for the subject mortgage loan."

An unintended consequence of Announcement SEL-2010-01 was the interpretation by some lenders that Fannie Mae was implementing a new requirement that the borrower be re-qualified up until closing. Indeed, we have worked with lenders that were asked by investors to repurchase loans because the former did not re-underwrite prior to closing for undisclosed liabilities that had led to excessive income ratios - even though, prior to closing, the lenders had not updated credit and had no knowledge that the borrowers had undisclosed liabilities. We successfully rebutted these repurchase demands, but Fannie's update lingered.

Many lenders believed that the March update required a new credit report just before the closing of the loan. The new Announcement (SEL-2010-11) now states that "this was not Fannie Mae's intent."

Fannie Mae has affirmed that lenders are not required to obtain a new credit report just before closing to check whether a borrower has taken out additional debt. If a borrower discloses or the lender discovers additional debt and/or reduced income after the initial underwriting decision was made, lenders are required to determine if a mortgage loan must be submitted for re-underwriting.

A re-underwriting will be required if the borrower discloses or the lender discovers additional debt(s) and/or reduced income after the underwriting decision was made up to and concurrent with the loan closing. The lender is not required to obtain a new credit report to verify the additional debt(s).

Still, a lender would be well advised to notify the borrower not to shop for a loan or take on additional debt between the time of the mortgage application and the closing date.

Effective Date

The new Announcement SEL-2010-11 replaces the undisclosed liabilities policy communicated in Announcement SEL-2010-01.

Compliance with the change is immediate, but must apply on loan applications dated on or after December 1, 2010.

For questions about this matter or assistance with mortgage compliance, please contact Jonathan Foxx, Managing Director.

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Highlights

Re-underwriting Requirements

The requirements address when a lender has to re-underwrite a mortgage loan after the underwriting decision has been made up to and concurrent with loan closing for both Desktop Underwriter® (DU®) and manually underwritten mortgage loans, and includes a new re-underwriting tolerance for manually underwritten loans and simplification and expansion of the DU resubmission policy.

Applying the Re-underwriting Criteria

Fannie requires the following steps to be taken if the borrower discloses or the lender discovers additional debt(s) and/or reduced income after the underwriting decision was made up to and concurrent with loan closing.

Changes to the DU Resubmission Policy

The following table describes the changes to the DU tolerances and resubmission requirements. The other tolerances in the Selling Guide remain unchanged (decreases to the interest rate, increases in income, changes to assets, and loan amount changes.

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Visit Library for Issuance

Undisclosed Liabilities and Re-underwriting Requirements
Fannie Mae: Announcement SEL-2010-11
August 13, 2010

Lenders Compliance Group is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.