Why a Short Sale Requires an Arm's Length Transaction

A couple talks to a businesswoman in their home

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

When people get into financial trouble, crooks can smell distress a mile away. They seem to constantly be cooking up schemes that take advantage of those homeowners who are facing foreclosure.

Due in part to the short sale flippers and shady double-escrow deals on short sales, banks have cracked down.

Why Banks Require an Arm's-Length Affidavit in 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 that 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 effect, means the sellers have repurchased their home at maybe half the cost, which greatly benefits those sellers. But, banks make the rules and say sellers can't benefit. If they wanted sellers to benefit, they would agree to a loan modification.

What a Short Sale Arm's-Length Affidavit Contains

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 arms-length affidavit:

  • It references the property address, names of the sellers, buyers, agents, and the fact that it 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 or special agreements among buyers, sellers, and/or agents.
  • Once the transaction closes, the sellers will not rent back the home or try to 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 arms-length affidavit for your short sale and then violate it, you could be held liable for mortgage fraud. Mortgage fraud falls under the jurisdiction of the F.B.I.

Moreover, if anybody tells you that it's alright to sell to a relative, make sure you clarify your relationship with the buyer to the bank before closing.