Short Sales and Straw Men

A prospective client contacted me regarding the purchase of a house being sold at “short sale.” The prospect explained that the property owner is a relative, and the money to buy the property would be coming to the prospect through other relatives. The family desires to keep the property owner in the house after the sale.

What is a short sale? According to Wikipedia:

“A short sale is a sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property, and the property owner cannot afford to repay the liens’ full amounts and where the lien holders agree to release their lien on the real estate and accept less than the amount owed on the debt. Any unpaid balance owed to the creditors is known as a deficiency. Short sale agreements do not necessarily release borrowers from their obligations to repay any shortfalls on the loans, unless specifically agreed to between the parties. . . A short sale is often used as an alternative to foreclosure because it mitigates additional fees and costs to both the creditor and borrower. Both often result in a negative credit report against the property owner.” [Footnotes and hyperlinks omitted.]

The essence of the short sale is the bank’s agreement to accept less than the full amount owed in exchange for releasing the mortgage. The buyer receives title to the property free and clear of the mortgage lien.

Obviously, this type of transaction begs for an arrangement between the selling property owner and the buyer so that the seller doesn’t really lose the property. So, sellers desire to make side agreements with relatives or friends to act as a sham buyer, or “straw man.” Once the short sale is complete, the buyer transfers title back to the seller. In practice, this means the seller is able to get the property back at substantially reduced cost, thereby benefiting financially from the transaction. Banks are aware of this and they do not want the seller to gain in any way from a short sale.

To guard against the straw man transaction, banks will require both the seller and the buyer to sign affidavits affirming that the buyer is not a relative, business associate, or has a business interest with the seller, and that there are no hidden agreements between the buyer and seller that would allow the seller to remain in the property or regain ownership after the sale. If it’s later discovered the parties lied in their affidavits, they could be prosecuted for bank fraud.

Best to run away from one of these!