Why a Short Sale Requires an Arm's Length Transaction

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An arm's-length affidavit is a written promise to a lender that the parties involved in a sales transaction don't know each other. It states that there is no pre-existing relationship between the seller and the buyer.

When people get into financial trouble, bad actors can smell distress a mile away. Scammers seem to constantly be cooking up schemes that take advantage of homeowners who are facing foreclosure. Due in part to shady deals on short sales, many banks have cracked down and require an arm's length sale.

What Is a Short Sale?

A short sale is an alternative to foreclosure. In a short sale, a lender allows a homeowner to sell their home to pay off their mortgage. What makes it a short sale is that the lender will accept the sales price, even if it's not enough to pay off the balance of the homeowner's mortgage. The process varies by state, and in some states, the lender may be able to collect the difference between the sales price and the mortgage balance.

Before moving forward with a short sale, homeowners should ask their lender for a waiver of deficiency. They may also want to review their options with an attorney or a HUD-approved housing counselor.

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 lender in an attempt to prevent sellers from selling to a relative. It's designed 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 can't 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 the 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. The seller is in the same home, but with a significantly smaller mortgage. But, banks make the rules and say sellers in a short sale can't benefit other than being able to move out of their home with a short sale, and not a foreclosure, on their credit report.

It's best for everyone involved that the transaction is arm's length. If you're on either side of a short sale, work with a reputable real estate agent with experience in short sales, and don't try to circumvent the system.

If you're experiencing difficulties in paying your mortgage, talk to your lender. Be cautious about potential scams and read any documents carefully before signing.

What a Short Sale Arm's-Length Affidavit Contains

Most lenders create their own arm's-length affidavits. The specifics are typically non-negotiable. Further, the language can vary from one affidavit to another. The following are 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 arm's-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 FBI.

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