Short Sales Fraud Costs Lenders $310 Million

Lenders lost about $310 million in the last two years unnecessarily because of short sale fraud in one out of 53 short sale transactions, according to CoreLogic. That's not a big surprise when you consider that short sales are up 700 percent compared to just two years ago.

Over half of all short sales (55.8 percent) during 2009 and 2010 happened in four states: California, Florida, Texas and Arizona. As job growth remains slow and housing prices remain weak, CoreLogic projects this trend will continue to be a significant factor for the mortgage marketplace.

CoreLogic looked at 250,000 short sale transactions since 2008 as part if its study. CoreLogic's database includes 98 percent of all real estate transactions and 85 percent of existing mortgages.
CoreLogic wrote in its study that lenders "often consider short sales the lesser of two evils compared to foreclosure -- a way they can minimize their overall losses. Losses on prime loans that go into foreclosure, for example, are 10 percent to 12 percent higher on average than those for short-sold loans. Generally speaking, all parties fare better when foreclosures are prevented."

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For lenders, the primary objective should be to mitigate unnecessary losses, according to Tim Grace, senior vice president of Fraud Analytics at CoreLogic. He thinks the best way to do this is through collaboration among lenders by sharing pre-closing and post-closing information. CoreLogic does this through its Mortgage Fraud Consortium.

Some key findings of its short-sale study include:
  • Approximately 4 percent of short sales are sold again within 18 months.
  • Short-sale transactions are "risky" for lenders when the second sale price is vastly higher than the initial short sale or when the second sale transaction happens too soon after the first.
  • The exact definition of short-sale fraud continues to evolve. CoreLogic found a consistent pattern of lenders incurring more loss than necessary in some short sales. About one in 53 short-sale transactions (1.9 percent) were part of an "egregious flip." CoreLogic deemed these risky.
  • "Only by leveraging multiple-lender data and experience can individual lenders see negative short-sale risk patterns in time to avoid the financial consequences," CoreLogic concludes.

One example of a short-sale fraud scenario given in the study showed that a real estate agent received a $120,000 offer on a property. Shortly after that time an investor made a $100,000 offer. The agent only shows the lender the lower $100,000 investor offer. After closing that deal, the agent then negotiates a second deal with the private party willing to pay $120,000. In some cases the investor may even disclose his intent to resell, but questionable deals include a resale at a profit just one day after the short sale closes. With a second closing so close, is this fraud, even though the investor indicated his intent to sell?

Whether or not a short sale is fraud becomes a bit grayer when the investor who got the home for $100,000 does some improvements before selling the home for a higher price, even if the investor resells the home in just 60 days.

While short sales will likely be a part of this real estate market for at least a few more years, lenders will be looking closer and closer at these deals -- especially if they involve a resale within 60 to 90 days. If you do plan to buy a short sale or the resale of a short sale, expect more scrutiny of the deal than you would with a traditional sale. Be sure you have the time to wait as the lender does its due diligence to review the deal.

Lita Epstein has written more than 25 books, including "The 250 Questions Everyone Should Ask About Buying a Foreclosure."

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