Cash back at closing
From CaseyPedia
Cash back at closing is a trick whereby the buyer and seller of a piece of real estate agree that the seller will make a payment to the buyer "outside of escrow"; often purportedly to "help cover closing costs".
The net effect of the payment is to trick the mortgage lender into lending the buyer more money than the buyer would have qualified for.
Because real estate transactions in many states are completed without help from an attorney, brokers often are the only layer between their clients and the lender. In many cases that leaves the broker and the buyer liable if they are not properly disclosing the true financial terms of the deal.[1]
California is one state where transactions are normally completed without the assistance of an attorney. Tom Pool, spokesman for the California Department of Real Estate, said undisclosed cash back deals could lead a broker to have his or her license suspended. Brokers are fiduciaries, Pool said, so are obligated to report truthfully to the principals in the deal. If the buyer defaults on an artificially inflated loan, leading to a foreclosure, that buyer could be prosecuted for fraud.[2]
The key to avoiding liability is fully disclosing any cash deals.[3] Disclosure is through the HUD-1 settlement statement.
If the seller puts money in escrow for repair or renovation purposes, there is no additional risk for the lender. If cash is exchanged and the lender doesn’t know about it, the lender isn’t getting all the information to evaluate how risky the loan actually is.[4] In California, money put in escrow by the seller should does not exceed 3% of a home's sale price.
Consider a hypothetical transaction where Buyer and Seller agree that Seller's house is worth $500,000; and that Buyer would like to purchase the house from Seller. Buyer does not have enough cash to pay for the purchase without financing, so Buyer seeks to borrow money from a lender, secured by the property. Mortgage lenders often require that the Buyer have a certain loan to value ratio; this means that the lender will only lend up to, typically, 70% or 80% of the lender's estimate of the fair market value of the property.
If Lender will loan at an 80% loan to value ratio on the hypothetical $500,000 property, this means that Buyer will have to come up with $100,000 in cash at closing in order to purchase the property.
However, if Buyer and Seller agree to a Cash back at closing transaction, then Buyer and Seller will agree on an artificially inflated sales price - for example, $525,000 in the hypothetical described above. Buyer's down payment is now $105,000, and Lender provides $420,000 in funds. The transaction is closed, and Seller pays Buyer the extra $25,000 (representing the difference between the $500,000 actual value and the $525,000 inflated value). The result is that Lender has now funded a loan where the loan to value ratio is $420,000/500,000 or 84%, or $20,000 beyond Lender's acceptable risk threshold of 80%.
Another variation of this trick involves convincing the seller of the property - if the seller has 100% equity in the property - to lend the buyer part of the purchase price, and for that mortgage to be subordinate to another mortgage from a traditional (bank) lender. The unethical buyer borrows, say, $300K from the seller (whose loan is in second position); and then also borrows $300K (against a $500K home) from a traditional lender (whose loan is in the first position). The unethical buyer can walk away with the extra $100K ($200K of the bank lender's funds went to the seller, with $100K going to the buyer) and make no payments on either loan. Eventually, the bank lender will foreclose, forcing the original seller to come up with the $300K owed to the bank lender or lose their equity in the property. The original seller also forecloses - so the bank lender gets their $300K back, the seller owns their property (but subject to a $300K mortgage, partially offset by the $200K the seller got at closing), and the buyer has $100K they're not entitled to. To date, this pattern has not been identified in Casey Serin's transactions - but given his disdain for details, it's perfectly possible that someone will do this to him.
[edit] References
- ↑ Some Cash-Back Home Deals May Be Illegal, Associated Press article by Vinnee Tong, October 2006
- ↑ Associated Press article by Vinnee Tong, October 2006, "ibid."
- ↑ Associated Press article by Vinnee Tong, October 2006, "ibid."
- ↑ Associated Press article by Vinnee Tong, October 2006, "ibid."
