Short-sale properties are increasingly common in housing slumps, or down markets. With lender permission, financially distressed homeowners can sell their property for an amount which falls short of paying off the mortgage debt. Because lenders take the financial loss in a short sale, they set rules for this transaction type. Nearly all lenders require you to sell to an unrelated third party; therefore, selling your house to someone with a family-type or business relationship to you is prohibited.
Lenders often prefer to write off a loss from a short sale, rather than undergo the lengthy and expensive foreclosure process to recoup their money. The seller retains possession and responsibility of the home until the sale closes, which typically takes several months. Lenders require the home to be listed on the open market -- usually by a real estate broker -- for a minimum of three or four months to ensure sufficient marketing and optimal offers.
Fraud in short-sale transactions occurs in various forms. Flipping, or selling the home for a major profit immediately after buying it as a short sale, is usually prohibited. Lenders place restrictions on buyers which require them to hold on to the home for a minimum amount of time before selling. Another scheme involves sellers who remain in possession of their home even after it sells, either renting or buying it back from the buyer for a lower amount than they previously paid. To circumvent fraud the parties to a short sale cannot be related by blood, family, marriage or a business partnership. The exact parameters of what constitutes a relationship may vary by lender.
Lenders include an arm's length clause or affidavit within their short-sale paperwork. An arm's length transaction involves a buyer and seller who are both dealing in their own best interests. Because they are at arm's length -- distanced and not closely connected -- the seller tries to obtain the highest price possible for the lender. A lender may require confirmation that the transaction is arm's length up-front before approving an offer or immediately after approving it.
Lenders may use a short-sale affidavit that encompasses all short-sale rules, including the confirmation that parties are unrelated and that no behind-the-scenes deals have been made. Buyers, sellers, agents and escrow agents may have to sign the short-sale affidavit attesting that buyer and seller are not colluding -- or have any contract the lender is unaware of. If the lender becomes aware of a privy deal made between relatives after signing the document, it may legally pursue the parties for damages claiming fraud.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.