Our recent New York Times Magazine article on the use of cash-back transactions in home sales produced a mountain of e-mail responses. Among the most interesting was this one from New York attorney Nishani Naidoo, a former real estate lawyer and member of the New York State Bar Association’s Real Property group. He has been distressed by the growth of cash-back transactions, and has tried unsuccessfully to do something about it. He explains:
In order to buy a home, one typically needs to save 10 to 20% of the purchase price for a down payment. The remainder of the purchase price is typically financed by a mortgage. The need to save for a down payment is one of the biggest barriers for someone wanting to be a home owner. It involves living below one’s means; saving for several years; and discipline. To the bank, however, this all means that the new home owner has a vested interest in making their mortgage payments since their life savings is invested in the home from Day 1.
A new form of financing arose in recent years, however, that all but eliminated the need to save for a down payment. This new form of financing was called the “seller’s concession” and is easiest to explain by way of an illustrative example: A buyer sees a house she likes and bids $200,000 for it. Since she is the highest bid, the seller accepts her offer. However, the price written into the contract is $240,000 with a $40,000 seller’s concession. In other words, the price is simultaneously increased by $40,000 and decreased by $40,000. The reason for this is that the buyer can then apply to the bank for a loan based upon the $240,000 purchase price. If the buyer obtains 90% financing, then her loan will be for $216,000, or $16,000 more than the actual price she is actually paying for the house.”
While all of this may sound like fraud, it is not, at least according to the New York State Banking Department, which explained as follows in response to my inquiry:
“According to your letter, a ‘seller’s concession’ is an amount by which the bargain for sale price (the “True Sale Price”) for real property is increased for the sole purpose of enabling the buyer to obtain a higher loan. Effectively, at the completion of the transaction, the seller receives the amount of the True Sale Price, and the buyer gets a loan for an amount (the ‘Contract Sale Price’), which when added to the down payment is in excess of the True Sale Price. The excess amount (difference between the True Sale Price and Contract Sale Price), or seller’s concession is typically used to pay for some, or all of the closing costs incurred by the borrower in the transaction.
From the above related facts, it is clear that the Contract Sales Price, including any seller’s concession, is fully disclosed to the lending institution in the contract of sale. Based on the fact that this price is fully disclosed, the Department is of the opinion that a seller’s concession would not ipso facto constitute fraud since, generally, the determination by a lending institution as to whether it should make a loan is based on a fully disclosed Contract Sale Price. In reaching this conclusion, the Department also notes that under general underwriting guidelines, lending institutions make a decision on whether to lend, or not, only after such institution has received an appraisal of the subject property and has made a determination that the property’s value is in line with the loan amount and that the borrower has the ability to repay the loan.”
In other words, where is the fraud if everyone is aware that this is going on? However, an astute observer must ask two questions: (1) if the seller had advertised her house in the market and the highest bidder was $200,000, how did the appraiser just a few short weeks later appraise the home for $240,000?; and (2) why doesn’t the bank just advertise that they are willing to provide loans in excess of 100% of the contract price?
The answer to this riddle may lie in the fact that most banks securitize their home loans — that is, they do not hold these loans on their balance sheets but sell them to the capital markets. While there may be no fraud on the buyer, the seller, or the bank, there may yet be a fraud if this new type of financing is not fully disclosed to the capital market investors.
If this practice is disclosed, then it can be presumed that the investors factor it into their models and price their purchases of mortgage backed securities accordingly. If it is not, then it is a safe assumption that they are holding a portfolio that is much riskier than they had bargained for. If the loan was in excess of the market value from Day 1, as the housing market declines, this difference – and the capital market investors’ losses – will grow accordingly.
As they start to lose money on these portfolios, the willingness of the capital market investors to supply of capital to the housing market will decline. When people are unable to obtain mortgages, the demand for houses will fall. As demand falls house prices will fall. And as house prices fall, the losses that capital market investors sustain will increase, making them less willing to supply capital to the housing market …
Business Week just ran a story on the foreclosure rescue scams. It was an excellent article and, as far as I can tell, very accurate. I do not know how he got his information but he is right on. The National Consumer Law Center did a study on this as well. Even if you don’t agree with their politics, they are reporting on something that is real and that does happen. Part of why I think nobody paid much attention to this before was that it did not affect the rest of us: the people to whom this type of thing happens are often poor and minorities. It’s also pretty hard to gather data in this area. However, the fallout in the subprime market is making people start to realize that this does affect us all. And I am not sure if they’ve made the connection yet. But part of the huge rise in housing prices is because of this since — well, if housing prices in Jamaica, Queens, start to rise, then prices in the neighborhood next to it rise, and so on and so on. You could not get a house for less than $400,000 in Jamaica in 2004. If Jamaica commands that price, then Astoria is definitely going to be a lot higher, and Manhattan a heck of a lot higher.
and 
. You can also watch it on 
There is a big difference between a seller’s concession that is disclosed to the lender and one that is not. Most lenders, as a rule, would not allow a 10% concession.
Most of the cash-back transactions are conducted fraudently. They are not disclosed on the HUD-1 settlement statement. Typically the lender will also require the buyer to execute a declaration stating that they are not getting cash back from the seller. The buyer will sign that fraudulently as well.
It takes a little bit of sophistication to pull this off, so typically the real estate agent is aware of the fraud. BUT, they only get their commission if the sale closes.
There is a big difference between a seller’s concession that is disclosed to the lender and one that is not. Most lenders, as a rule, would not allow a 10% concession.
Most of the cash-back transactions are conducted fraudently. They are not disclosed on the HUD-1 settlement statement. Typically the lender will also require the buyer to execute a declaration stating that they are not getting cash back from the seller. The buyer will sign that fraudulently as well.
It takes a little bit of sophistication to pull this off, so typically the real estate agent is aware of the fraud. BUT, they only get their commission if the sale closes.
This type of practice is effectively prohibited by the underwriting guidelines of Fannie Mae,Freddie Mac,FHA, VA, Guaranteed Rural Housing and most likely all Alt-A investors and nearly all sub-prime investors. In short, any institution who securtizes their mortgage production.
A purchase-cash-back seller concession scheme may be allowed in hard-money lending. Hard money loans are typically arranged by a mortgage broker who “knows a guy” with money to lend. The guy charges a double digit interest rate for the convenience. Also, a small community bank that portfolios their loans, may go along with an excessive seller concession.
Why will the guy and the small bank do this, when no one else will? The guy and the small banker are most likley local and have a much better knowledge of the local real estate market than the
Wall Street.
The $200,000 home, with a $240,000 sales price could experience rapid value appreciation. The buyer, the guy and the banker may be aware of that the town council is about to pass a 5 year residential building moratorium. Of course, they could all be idiots , but the spillover effects of their idiocy did not cause the housing bubble or the conventional non-conforming MBS melt down.
There’s enough soft headed commentary and proposed regulation of “liar” loans (no income no asset verification). The last thing poor and middle class aspiring home owners need is restrictions on low and no-downpayment mortgage programs that Fannie, Freddie, , sub-prime and Alt-A investors developed over the past 15 years.
This type of practice is effectively prohibited by the underwriting guidelines of Fannie Mae,Freddie Mac,FHA, VA, Guaranteed Rural Housing and most likely all Alt-A investors and nearly all sub-prime investors. In short, any institution who securtizes their mortgage production.
A purchase-cash-back seller concession scheme may be allowed in hard-money lending. Hard money loans are typically arranged by a mortgage broker who “knows a guy” with money to lend. The guy charges a double digit interest rate for the convenience. Also, a small community bank that portfolios their loans, may go along with an excessive seller concession.
Why will the guy and the small bank do this, when no one else will? The guy and the small banker are most likley local and have a much better knowledge of the local real estate market than the
Wall Street.
The $200,000 home, with a $240,000 sales price could experience rapid value appreciation. The buyer, the guy and the banker may be aware of that the town council is about to pass a 5 year residential building moratorium. Of course, they could all be idiots , but the spillover effects of their idiocy did not cause the housing bubble or the conventional non-conforming MBS melt down.
There’s enough soft headed commentary and proposed regulation of “liar” loans (no income no asset verification). The last thing poor and middle class aspiring home owners need is restrictions on low and no-downpayment mortgage programs that Fannie, Freddie, , sub-prime and Alt-A investors developed over the past 15 years.
Stephen…
There seems to be a lot of missing facts and misrepresentations in your post.
1. Fannie / Freddie don’t allow more than 3% of the price to be “seller concessions”
2. Who is going to appraise this house 20% over market? Or moreover who is going to sell for 20% under market?
This is NOT a typical transaction and would be considered fraud. Most lenders watch very closely for inflated values as they have buy-back provisions in the MBS market this sort of loan would be pushed back to the originator.
Your post shows that you either don’t know the mortgage market very well, that you have some axe to grind, or that you didn’t do any research.
Stephen…
There seems to be a lot of missing facts and misrepresentations in your post.
1. Fannie / Freddie don’t allow more than 3% of the price to be “seller concessions”
2. Who is going to appraise this house 20% over market? Or moreover who is going to sell for 20% under market?
This is NOT a typical transaction and would be considered fraud. Most lenders watch very closely for inflated values as they have buy-back provisions in the MBS market this sort of loan would be pushed back to the originator.
Your post shows that you either don’t know the mortgage market very well, that you have some axe to grind, or that you didn’t do any research.
I wanted to clarify first that there are two types of things being talked about in the post: sellers concessions and straw buyer transactions. The two are not related. Seller’s concessions are explained in the post (putting the contract price up, etc.) and straw buyer transactions in the Business Week article.
First, in response to “phoyd” from Italy. In New York State, the seller pays a transfer tax upon the sale of the property. When the price is increased in this way, the amount of the transfer tax increases too. Since this “seller’s concession” is really only being given to enable the buyer to get a loan, the buyer also agrees to pay any increased taxes that the seller incurs because of this.
Second, in response to “egretman” who posted about straw buyer transactions. This is exactly the response I got from the Queens DA when I first approached them. And to a certain extent, I do agree with you. My biggest problem is that a straw buyer transaction is illegal. In fact, it is so illegl that it is specifically discussed in the FBI’s Financial Crimes Report to the Public last year (http://www.fbi.gov/publications/financial/fcs_report2006/financial_crime_2006.htm#Mortgage).
So while it is true that it is hard to feel sympathy for a straw buyer and seller who agreed to do this, what is very frustrating is that licensed professionals — lawyers, real estate brokers and mortgage brokers — participate in this. What ends up happening in a straw buyer transaction is that the buyer’s credit is eventually ruined and the seller eventually loses the house. However, the lawyers and brokers get off scott free — in fact, they are compensated handsomely. And they just go on to their next straw buyer deal. The banks/financial markets are also not affected by this (yet) since the houses have so far fetched more than the amount of the loan in the foreclosure auctions (straw buyer transactions are also equity stripping transactions so, unlike seller’s concessions, they are done to homes with plenty of equity). In any event, as the market starts to turn south, the amount the bank gets at the foreclosure auction will start to be less than the loan, and then we’ll see more interest from the banks/title companies in these transactions. The New York Legislature has acted (or reacted) in passing the Home Equity Theft Prevention Act. Again, this, in my opinion, is really dumb since one of the exit mechanisms for a home owner in this situation is to sell his/her home. What capitalistic investor will purchase this home if the distressed homeowner can just come back two years later to reclaim title? (that’s the import of the act). What will end up happening is that more and more homes will go into full-fledged foreclosure, with a sale at a court auction. In essence, all this Act did was eliminate the situation where the distressed homeowner could sell the home on his/her own thus salvaging some of their credit history and also trying to get a higher price (auction prices tend to be lower because of the lack of information — no title search; no home inspection; etc.). Anyway, all this act really does is HURT the distress homeowner since they now have to go to a full-fledged foreclosure auction, with the resultant ruin of their credit history and lower auction price, etc. The people who enacted the legislation are well intentioned. The problem, though, is that most people miss the fact that this is fraud and we already have laws to deal with fraud and, in particular, the state should not grant licenses to people who commit fraud and should certainly be taking away the licenses of those lawyers, real estate brokers and mortgage brokers who commit fraud. I would go a step further and say that the state should also prosecute them, but then this may all be far too rational for a State legislative body to comprehend. Hence the Home Equity Theft Prevention Act. One would think that “theft” was already unlawful. I could go on, but I think I’ve made the point.
I wanted to clarify first that there are two types of things being talked about in the post: sellers concessions and straw buyer transactions. The two are not related. Seller’s concessions are explained in the post (putting the contract price up, etc.) and straw buyer transactions in the Business Week article.
First, in response to “phoyd” from Italy. In New York State, the seller pays a transfer tax upon the sale of the property. When the price is increased in this way, the amount of the transfer tax increases too. Since this “seller’s concession” is really only being given to enable the buyer to get a loan, the buyer also agrees to pay any increased taxes that the seller incurs because of this.
Second, in response to “egretman” who posted about straw buyer transactions. This is exactly the response I got from the Queens DA when I first approached them. And to a certain extent, I do agree with you. My biggest problem is that a straw buyer transaction is illegal. In fact, it is so illegl that it is specifically discussed in the FBI’s Financial Crimes Report to the Public last year (http://www.fbi.gov/publications/financial/fcs_report2006/financial_crime_2006.htm#Mortgage).
So while it is true that it is hard to feel sympathy for a straw buyer and seller who agreed to do this, what is very frustrating is that licensed professionals — lawyers, real estate brokers and mortgage brokers — participate in this. What ends up happening in a straw buyer transaction is that the buyer’s credit is eventually ruined and the seller eventually loses the house. However, the lawyers and brokers get off scott free — in fact, they are compensated handsomely. And they just go on to their next straw buyer deal. The banks/financial markets are also not affected by this (yet) since the houses have so far fetched more than the amount of the loan in the foreclosure auctions (straw buyer transactions are also equity stripping transactions so, unlike seller’s concessions, they are done to homes with plenty of equity). In any event, as the market starts to turn south, the amount the bank gets at the foreclosure auction will start to be less than the loan, and then we’ll see more interest from the banks/title companies in these transactions. The New York Legislature has acted (or reacted) in passing the Home Equity Theft Prevention Act. Again, this, in my opinion, is really dumb since one of the exit mechanisms for a home owner in this situation is to sell his/her home. What capitalistic investor will purchase this home if the distressed homeowner can just come back two years later to reclaim title? (that’s the import of the act). What will end up happening is that more and more homes will go into full-fledged foreclosure, with a sale at a court auction. In essence, all this Act did was eliminate the situation where the distressed homeowner could sell the home on his/her own thus salvaging some of their credit history and also trying to get a higher price (auction prices tend to be lower because of the lack of information — no title search; no home inspection; etc.). Anyway, all this act really does is HURT the distress homeowner since they now have to go to a full-fledged foreclosure auction, with the resultant ruin of their credit history and lower auction price, etc. The people who enacted the legislation are well intentioned. The problem, though, is that most people miss the fact that this is fraud and we already have laws to deal with fraud and, in particular, the state should not grant licenses to people who commit fraud and should certainly be taking away the licenses of those lawyers, real estate brokers and mortgage brokers who commit fraud. I would go a step further and say that the state should also prosecute them, but then this may all be far too rational for a State legislative body to comprehend. Hence the Home Equity Theft Prevention Act. One would think that “theft” was already unlawful. I could go on, but I think I’ve made the point.