This article educates readers about how to avoid inadvertently committing loan fraud. Another article on our website, “How to Commit More Loan Fraud,” intends to further help real estate professionals and sellers from inadvertently becoming caught up in such a scheme.
Question: I have brokered a transaction in which the seller is willing to give the buyer a $10,000 rebate because of the poor condition of the roof. How should I reflect this adjustment?
Response: Lenders generally make real estate-secured loans based upon two considerations, the credit worthiness of the borrower and the value of the collateral. Lenders estimate the value of the collateral by: (a) having the property appraised and (b) examining the price the buyer is willing to pay. Appraising is not an exact science. Appraisers make mistakes. They are subject to subtle pressures (and sometimes not so subtle pressures) to increase the value of the property. Buyers don’t intentionally pay more for a property than it is worth, unless there is some value coming back to the buyer inducing the buyer to pay an inflated price.
Any time value is coming back to a buyer out of a transaction, the lender has a right to know so that the lender can decide whether the rebate should be treated as a price concession. Consider a buyer who has entered into a contract to purchase a property for $200,000. After learning of a roof problem, the seller agrees to pay the buyer $10,000 in exchange for the buyer taking the condition of the property at closing subject to the roof defect. We will examine two of the many ways of handling this situation.
In the “Price Reduction” scenario, the seller and buyer reduced the price by $10,000 to $190,000. The buyer is purchasing the property with a 90% loan-to-value mortgage. The loan will be for $171,000 and the buyer will need to bring approximately $19,000 to close.
In the “Rebate Scenario” the price is kept at $200,000, but the seller rebates $10,000 to the buyer. The lender does not treat the rebate as a price concession, either because the lender is not aware of the rebate, or because the lender has simply chosen not to treat it as a price concession. Under this rebate scenario, the buyer borrows $180,000 with a 90% loan. While the buyer brings $20,000 to closing, the buyer receives a rebate of $10,000 from the seller so that the buyer’s net out-of-pocket cash is only $10,000, $9,000 less than under the Price Reduction scenario.
In both cases, the buyer has paid $190,000 for the property. In the Price Reduction scenario the buyer has put up more cash, but benefits by having a lower mortgage. In the Rebate Scenario, the buyer has paid less cash, and has a higher mortgage. Because cash is precious, many buyers will prefer the Rebate Scenario. For some buyers it is not a matter of preference. They don’t have the $19,000 and have no choice but to try the rebate scenario or not purchase the property.
However, aware that many lenders will treat the $10,000 rebate as a price concession, participants in the deal sometimes hide the rebate from the mortgage investor who funds the loan. Since everyone knows that an under the table rebate of $10,000 to the buyer post-closing is an illegal “kickback,” more subtle schemes have evolved in an attempt to make the kickback seem less fraudulent.
For example, a scheme might be worked out where the mortgage broker nominally charges the borrower $10,000 in points and fees. The seller agrees to pay for those loan charges and this payment is disclosed to the mortgage investor. However, unbeknownst to the mortgage investor, the mortgage broker then rebates the $10,000 to the buyer.
Another example is that instead of bringing $20,000 in cash to the closing, the seller agrees to accept $10,000 in cash, and carry a second mortgage for $10,000. The seller-carry second deed of trust is disclosed to the lender, but there is a side agreement that the second mortgage will never be paid.
Loan fraud requires a misstatement of a material fact to a lender. A lender who is aware of the $10,000 rebate may choose not to treat it as a price concession and make the loan based upon a $200,000 valuation. If the $10,000 rebate is memorialized in a contract amendment provided to the lender, and the lender chooses to make the loan based upon a $200,000 valuation, there is no fraud.
The Nehemiah and other down payment assistance programs are essentially institutionalized examples of disclosed rebates to buyers. If the lender and HUD are aware that the seller is paying expenses for a buyer and they choose not to treat these credits as a price concession, there is no loan fraud. (Whether these programs are good public policy remains to be seen.
Sometimes the schemes are orchestrated by persons who assure the other participants that “this is done all the time” and that he or she has never had a problem with it. The person directing the scheme may be telling the truth. Lenders tend not to notice loan fraud unless the loan goes into default. Over the last decade or so we have had a strong real estate economy. Appreciation tends to cover up loan fraud. But declining property values have begun to reveal problems. People in the real estate industry should be especially vigilant to avoid misleading mortgage investors about the true price which the buyer pays for the property.
Click on the following link to read “How to Commit More Loan Fraud.”