Why Does the Bank Require an Arm's-Length Affidavit for a Short Sale?

arm's length agreement
Arm's length agreements are required for many short sales. © Big Stock Photo

Why Does the Bank Require an Arm's-Length Affidavit for a Short Sale?

A reader says:"We're in a terrible mess. My husband lost his job last spring, and our house isn't worth anywhere near what we paid for it. The bank turned down our request for a loan modification, so we have no choice but to do a short sale. When I told my mom that we were going to sell the house, she offered to buy it from us and let us rent back, so we wouldn't have to move. But now the bank has sent us an arm's-length affidavit to sign, and it looks like they won't let us sell to my mom. I don't understand any of this. Why does the bank require an arm's-length affidavit on this short sale?"

I sense your frustration and confusion about the arm's-length affidavit and know first hand how long and painful the short sale process can be as I handle many short sales in Sacramento. Lots of short sale sellers tell me that they had initially tried to do a loan modification and were rejected by their banks. You're not alone. It's as though banks want to dump their inventory and get everything off the books rather than help a homeowner stay in a home.

An arm's length affidavit is primarily to ensure the bank that the parties do not know each other, there is no pre-existing relationship between the seller and the buyer.

The reason you are being asked to sign an arm's-length affidavit is because banks are trying to put a stop to mortgage fraud. When people get into financial trouble, crooks can smell distress a mile away. These thugs crawl out of the gutters and seem to be constantly cooking up schemes that take advantage of those homeowners who are facing foreclosure.

I'm not saying that your intentions were not honorable, but due in part to the short sale flippers and shady double-escrow deals on short sales, banks have cracked down.

What Are the Reasons For an Arm's-Length Affidavit for a Short Sale?

An arm's-length affidavit is a document created by a short sale bank in an attempt to prevent sellers from selling to a relative and to curb mortgage fraud.

The reason the bank does not want a seller to transfer title to a relative in a short sale is because sellers cannot profit from a short sale.

Sometimes sellers make side agreements with relatives or friends to act as a straw buyer. Then, after the transaction closes, those pretend buyers quickly transfer title back to the seller. This practice, in affect, means the sellers have repurchased their home at maybe half the cost, which greatly benefits those sellers. But banks make the rules, and banks say sellers can't benefit. If they wanted sellers to benefit, they would have agreed to a loan modification.

What Does an Arm's-Length Affidavit Contain?

Most banks create their own arm's-length affidavits. The specifics are typically non-negotiable. Further, the language can vary from one affidavit to another. Following are the points contained in a basic arm's-length affidavit:

  • The arm's-length affidavit references the property address, name of the sellers, buyers, and agents, and the fact this is an arm's-length transaction.
  • No party to the short sale contract is a family member, business associate or a person who shares a business interest with the seller.
  • There are no hidden terms nor special agreements among the buyers, sellers and / or agents.
  • Once the transaction closes, the sellers will not rent back the home nor regain title to it, unless the bank permits.
  • None of the parties will receive any compensation except for the commission paid to the agents.

If you sign an arm's-length affidavit for your short sale and then violate it, you could be held liable for mortgage fraud. Mortgage fraud falls under jurisdiction of the F.B.I. Moreover, if anybody tells you that it's OK to sell to a relative, make sure that you clarify your relationship with the buyer to the bank before closing. I don't know of any banks that will let you do it.

I also realize this doesn't sound fair, but it's how banks have decided to handle it. I hope you can find an arm's-length buyer before your home goes into foreclosure.

At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.