Commentary by Ralph R. Roberts
RISMEDIA, Dec. 27, 2007-In response to my article, “Realtor Caught in Cash-Back-at-Closing’s Crosshairs,” a newly licensed associate broker from Washington state e-mailed me asking whether a cash back at closing deal could ever be legal. His question applied to the following scenario:
The seller is facing foreclosure and his highly motivated to sell. The buyer has good credit, a suitable down payment, and a desire to make a deal. The home is listed and has been appraised at $480,000. The seller is willing to discount the home by $80,000. (The seller loses some equity in the home but dodges the foreclosure bullet and saves part of his credit in the process.)
Instead of purchasing the home for $80,000 less, the buyer agrees to pay the full price of $480,000 with the agreement that the seller will pay back an “incentive” at closing of $80,000. This would give the buyer the necessary funds to fix up the property.
The buyer delivers a real cash down payment that is proven to be in his bank account prior to the purchase, as per the bank’s requirements.
The bank has approved the loan based on its own appraiser’s evaluation and receives a suitable down payment of 5-20% depending on the loan requirements.
The broker then followed up with a couple of questions: “How can this be inappropriate or wrong if the seller takes a loss but is happy with the deal? Where is the harm if all is fully disclosed, and the bank is not put at any risk?”
Consumers and professionals often justify such deals by claiming that the true market value of the home shows that the bank is receiving sufficient collateral.
However, the true market value of the home is the lesser of the appraised price or the actual price paid for the property. In this case, the true market value of the property is not $480,000. It is actually the price the seller is willing to accept-$400,000. Presenting to the bank that the actual sales price is $480,000 is misleading and constitutes fraud.
As real estate brokers, we are often told that “As long as the information is presented on the HUD statement, the transaction is legal.” What happens in almost all situations such as the scenario presented here, is that the professionals involved create two HUD statements-one for the closing and another that is sent to the bank or they camouflage the $80,000 junior lien or a recently created obligation of the seller. In other words, all is not being fully disclosed.
This is obviously a deceptive practice designed to mislead the bank into approving a loan it would otherwise reject. If you have to create two HUD statements-one for the closing table and one for the lender or one that is camouflaged in some way to justify a transaction, then what you are doing is illegal. If the HUD was a person then it could be accused or indicted as a co-conspirator.
I know of only a handful of situations in which receiving cash back at closing is legal:
1. You refinance your mortgage to cash out some or all of the equity in your home.
2. Your agent agrees to refund a portion of his or her commission at closing.
3. The buyer makes a deposit into the escrow fund, obtains a 100% loan, and then receives a credit back. This isn’t considered cash back at closing, because it is the buyer’s own money.
Other than scenarios such as these, cash back at closing deals are unethical and illegal.
Now you might argue that illegal acts such as these are victimless crimes, but they do have the potential of causing harm. Consider the following:
– The buyer’s mortgage payment is higher than it needs to be, making it more difficult for the buyer to afford and more likely that the buyer will ultimately default on the mortgage.
– The bank approves a loan for $80,000 more than the true market value of the home. If the bank must foreclose on the home in the future, it may not be able to sell the home for enough money to cover the remaining balance of the debt.
– The inflated sales price influences the prices of homes in the same area, making housing in the area less affordable and boosting property taxes.
As you can see, there are good reasons behind the rules and regulations that govern real estate transactions. When we begin to bend those rules under the false assumption that nobody is getting hurt, we compromise the very integrity of the real estate industry and damage the industry on which we make a living.
Ralph Roberts is a real estate fraud expert and activist and co-author of Protect Yourself from Real Estate and Mortgage Fraud: Preserving the American Dream of Homeownership (Kaplan, August 2007). Visit www.FlippingFrenzy.com or contact Ralph at RalphRoberts@ralphroberts.com or 586.751.0000.