Cash Back From The Seller to the Buyer in Real Estate Sales
Yesterday I dealt with a very disturbing phone call from a would be client. He was very happy with the way I found bargain properties, and wanted me to find him such a property. All very well and good. But he said that a condition of the transaction had to be that he would receive cash back from the seller in order to rehabilitate the property while financing the entire amount. This is not so good.
I am well aware there are all kinds of self-proclaimed real estate gurus out there, many of whom push precisely this sort of strategy. That does not change the fact that it is *FRAUD*.
The lender evaluates a property based upon accounting principles, which is to say Lesser of Cost or Market. Whichever is less, the cost of the property or the market value. Market value is measured by the appraisal. It's not perfect, and it's not foolproof, but it's the best thing there is. Cost is measured by purchase price - the price at which a willing buyer and a willing seller exchanged the property. It has to be worth that much or the buyer would not have been willing to pay it, would they? It can't be worth more or the seller wouldn't have sold, would they?
Manipulating either purchase price or appraised value for financial purposes such as justifying a higher loan amount is fraud. Since there is no other rational reason to do that, it's pretty universal that manipulating appraisal value or purchase price is fraud.
Many people have all kinds of rationalizations why doing this sort of thing is permissible. "Real Estate goes up in value," "It'll be worth that much eventually," and "It'll be worth that after the renovations!" being very common. None of these addresses that fact that that's not the situation now, and the lender is lending based upon the value now, not later.
The purchase price, in particular, is the purchase price because that it how much money the buyer is paying and how much money the seller is receiving. But if the purchase price is $400,000 but the seller is returning $20,000 to the buyer, then the real purchase price is not $400,000, is it? The seller is only getting $380,000, and the buyer is only paying $380,000. If it was a cash transaction with no loan involved, there would be no doubt. If I hand you $400,000 and you hand me back $20,000, I've only given you $380,000, not $400,000, and there's no doubt about it. You've only got $380,000. Only the fact that there is a lender in the middle of most transactions gives any leeway to confuse the issue, and if you're hiding something about a transaction in order to induce some other party to perform a financial action they would not otherwise, that is a textbook definition of fraud.
Lest there be any mistake, you do have to hide it. If the terms of the purchase contract state that there will be this rebate, the lender will treat the purchase price as $380,000, and underwrite the loan based upon a $380,000 purchase price. Telling the entire truth defeats the possibility of it working, and once you have neglected to inform the lender of this significant fact, you are committing fraud.
Some people will cite the example of Seller Paid Closing Costs as justification for this, but that is an entirely different matter. Indeed, traditionally lenders treated seller paid closing costs, over and above the seller's usual share, as reducing the purchase price. It is only the last few years, when it has been pointed out that everything about real estate transactions is negotiable, and that the seller must have been willing to pay those costs in order to consummate that transaction, that the lenders began to allow it. But it is to be noted that all of that money is going to third parties, people who are being paid for their services in making the transaction happen, none back from the seller to the buyer.
Consider instead this scenario: Jim and Joe trade the stock of corporation A. The public sale price of that stock is $100 per share, but as soon as Jim has Joe's money, he quietly hands Joe back $20. The price Joe is paying Jim for the stock is $80, but to the observer unaware of the side transaction, it's $100. It's going to appear to the general public that both Jim and Joe consider that to be a fair trading price, and people will often be willing to pay both Joe and Jim that $100 per share price because it looks like that's the price, or think they're really "getting a deal" if Joe or Jim will sell to them for $98.
Now lest we be unclear, as soon as the side transaction comes to light, the SEC and FBI are going to sweep in and both Joe and Jim are going to find themselves charged with share price manipulation, which is to say, fraud.
The situation I've described as defrauding the lender in this instance is no different at the root. You are hiding a part of the transaction in order to induce the lender to give you a larger loan than they otherwise would have.
Now, before I leave this subject, I want to ask you what kind of an agent or loan officer you'd trust to commit fraud upon someone? When such activities are discovered, such agents and loan officers lose their license and usually go to jail. Do you want to do business with a loan officer or real estate agent who commits fraud? Who deserves to lose their license and go to jail? If they're willing to lie and commit fraud upon one part of the transaction at the lender's expense, why would they be unwilling to lie and commit fraud at someone else's expense? For instance, yours? If I were to point out some agent or loan officer who is under indictment for fraud, and is going to lose their license and go to jail as soon as the verdict comes back, I'm sure you'd all go right out and book a transaction in a hurry with them right now, right?
Now this would-be client quickly lost interest when I explained all of the above. He said, "I'll get back to you on the property!" and hung up. He'll find someone to help him out, no doubt about it. But that's one transaction a good professional wants no part of. I'm better off without him.
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