Identifying Short Payoff Fraud

Short Sale Fraud – While not yet a law or an official policy, problems loom on the horizon thanks to a new take on short sales. The news from Freddie Mac on short sales could cause serious legal and practical issues for real estate investors.

The organization posted a new educational article on April 16, 2010 titled “Emerging Fraud Trends: Short Payoff Fraud.” The article stated, in short, that short sales could be fraudulent if the lender does not have information about a pre-arranged flip of the property after the short sale to another buyer. This could spell trouble for investors who have been short-sale flipping, which means negotiating a short sale with the bank, then selling the property immediately to another buyer for a profit of a few thousand to tens of thousands of dollars.

The Freddie Mac poster went on to describe scenarios and red flags for short payoff fraud. The scenario involved a facilitator, whose description matched that of a real estate short sale investor, who negotiated a deal with a lender to short sale a home worth $80,000 with a debt of $100,000 for $70,000. In the scenario, the facilitator fails to notify the bank he has a higher offer, 95,000, on the house. When both transactions close and the facilitator pockets his profit, Freddie Mac considers him to have committed fraud since Freddie Mac has now taken a “larger than necessary” loss on the sale.

The article urges buyers, sellers and lenders to be on the lookout for short payoff fraud red flags. Flags include sudden default without explanation, borrowers current on other debts and buying entities. The article also says that resale options in contracts can be a red flag.

Finally, sellers, buyers and lenders are all encouraged to report this short payoff fraud if they are aware of a second purchase contract for a higher price. It may not be considered breaking the law, but it certainly looks like Freddie Mac wants to make short sales as difficult as possible for real estate investors.