If you fail to make your mortgage payments, the bank may eventually foreclose on your property. In some cases, the bank may allow you to conduct a short sale instead. In a short sale, the bank lets you sell the property at a price that may be lower than the mortgage balance you still owe, but there can be restrictions on who you are allowed to sell to.
Arm's Length Transaction
Even if you have a family member who is willing to help you out by purchasing your property, you may not be allowed to go through with the sale. Lenders usually require that short sales have to be arm's length transactions. This means that you must not have a relationship with the buyer. In some rare cases, the lender may allow a non-arm's length short sale, but you will probably have to jump through hoops to prove to the lender that there is no intention to commit fraud. You may have to sign additional documents to state that you will not stay in the property after the sale or buy it back at a later date. Lenders determine how to proceed in such situations on a case-by-case basis.
Lenders usually require an arm's length transaction in a short sale to make sure that the selling price is the property's actual market price. In a transaction between family members or friends, it's likely that the property would exchange hands at a figure that's lower than its market price.This rule serves to protect your mortgage provider by making sure that it will receive fair compensation for the sale.
Short Sale Fraud
In the past, allowing transactions between family members and friends had led to short sale frauds. According to Freddie Mac, one common plot has the borrower selling the property to a buyer who has previously agreed to allow the seller to stay in the property and to transfer the title back to the seller at a later date.
The arm's length policy has been blamed for throwing out residents who can otherwise fight to keep their homes. In the "Dorchester Reporter," Senator Elizabeth Warren argues that, as long as the transaction occurs at market value or the buyer places the highest bid, it should not matter whether the buyer and the seller know each other. Instead of viewing this as a fraud, she maintains that lenders should see this as a win-win solution.
- Making Home Affordable: Glossary
- Freddie Mac: Combat Short Sale Fraud with an Arm's Length Affidavit
- Bankrate: Would This be an Arm's Length Short Sale?
- Dorchester Reporter: FHFA's Senseless Arm's-Length Policy on Short Sales
- National Association of Realtors. "Short Sales & Foreclosures." Accessed June 30, 2020.
- American Bar Association. "A Checklist for Insuring a Short Sale." Accessed June 30, 2020.
- National Association of Realtors. "The Short Sale Workflow." Accessed June 30, 2020.
- Federal Trade Commission. "Getting a Mortgage After a Short Sale." Accessed June 30, 2020.
- National Association of Realtors. "Short Sale Relief on the Horizon?" Accessed June 30, 2020.
Edriaan Koening began writing professionally in 2005, while studying toward her Bachelor of Arts in media and communications at the University of Melbourne. She has since written for several magazines and websites. Koening also holds a Master of Commerce in funds management and accounting from the University of New South Wales.