By: Carrie Bay

With defaults continuing to mount and declining property values still widespread, the industry is seeing an increase in short sales. Such transactions are expected to burgeon even further now that the federal government has implemented its Home Affordable Foreclosure Alternatives (HAFA) program.

Under HAFA, servicers participating in the administration’s foreclosure prevention effort are required to consider a short sale for all homeowners that don’t qualify for a modification, and incentives are paid out to borrowers, servicers, and lien holders for successful short sales.

With the new policies and still-precarious market conditions, short sales are gaining in popularity among lenders and distressed homeowners alike, but as with any modus operandi that rapidly picks up steam, this proliferation can open the gate for fraudulent activity.

Experts say one area of the short sale process particularly vulnerable to fraud is property valuation. Bank-owned fraud attributed directly to schemes involving short sales and REO inventories has increased by 40 percent over the past year and has more than doubled from two years ago, according to market data from the California-based risk mitigation firm Interthinx.

The administration’s HAFA program allows broker price opinions (BPOs) to be used to determine the value of properties to establish a minimum offer for a short sale. Some industry groups claim the allowance of BPOs is likely to exacerbate the potential for fraud. They say that the real estate agents and brokers who perform BPOs have an inherent bias toward producing a fee for themselves, irrespective of ensuring a fair return for the lien holder or homeowner.

In response to these allegations, the National Association of Realtors (NAR) stressed that BPOs are completed by licensed real estate agents who have a detailed knowledge and understanding of real estate pricing and local market trends. The organization argues that BPOs are widely accepted in the industry because of their established

reliability and accuracy, and practitioners providing BPOs must adhere to a rigorous code of ethics and recognize their fiduciary responsibility to their clients.

While the Federal Bureau of Investigation (FBI) has described short-sale fraud schemes as “difficult to detect since the lender agrees to the transaction,” they are moving higher on the agency’s list of types of mortgage fraud to watch, with the number of cases mounting rapidly.

The FBI defines such fraud as: “Any material misstatement, misrepresentation, or omission relied upon by an underwriter or lender to fund, purchase, or insure a loan.”

Freddie Mac recently issued a notice to its servicers and real estate practitioners on what the GSE called an emerging fraud trend – short payoff, or short sale, fraud.

Short sale volume at Freddie Mac grew more than 1,000 percent from 2007 to 2009, and the GSE says this upward trend in volume leaves the market ripe for incidences of short payoff fraud.

According to a member of Freddie Mac’s Fraud Investigation Unit, any misrepresentation related to the buyer, a subsequent transaction at a higher prices, or the seller’s hardship reason to qualify for a short sale constitutes fraud.

The GSE outlined several red flags that might suggest short sale fraud:

• Sudden borrower default, with no prior delinquency history, and the borrower cannot adequately explain the sudden default.
• The borrower is current on all other obligations.
• The borrower’s financial information indicates conflicting spending, saving, and credit patterns that do not fit a delinquency profile.
• The buyer of the property is an entity.
• The purchase contract has an option clause to resell the property.

Treasury officials say they have already incorporated safeguards against fraud into HAFA. To participate in the program, borrowers and the licensed real estate agent who lists the property are required to sign a Short Sale Agreement (SSA) and sales contract attesting that the transaction is being conducted at arm’s length, meaning the property is not being sold to a relative.

In addition, buyers must agree not to resell, or “flip,” the home within 90 days of the closing date, and the lender/servicer must have an independent property valuation in hand that meets their pre-set net return requirement before agreeing to the short sale. Treasury officials say servicers should terminate the short sale agreement if any evidence of falsification or misrepresentation is discovered.

http://www.dsnews.com/articles/short-salesa-breeding-ground-for-fraud-2010-04-23