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Brad comments today on short sale negotiating companies.

Just two or three years ago, when loan modifications entered the public vernacular, fly-by-night operators hung their shingles, wishing to hop on the proverbial bandwagon. Homeowners were sinking fast into financial turmoil, and these snake-oil companies promised a way out. The problems were twofold: first, most of them were unlicensed. And second, most of them had little if any experience and consequently, the majority of attempts at loan modifications failed.

Recently, as short sales came to rule our landscape, with seemingly no end in sight, companies have been sprouting up all over the Las Vegas valley to take advantage of this latest craze. And I mean, literally, “take advantage”. The same two problems as mentioned above are ubiquitous. Law firms have even gotten into the fold, with TV spots, newspaper ads and billboards all touting their short sale expertise. Third party negotiating services have been spreading like wildfire, leeching onto the laziness and/or inability of real estate professionals too busy, too tired, too timid, and too inexperienced to handle their own negotiations.

These companies have come up with interesting ways to structure themselves, both from a legal standpoint and a financial one. In Nevada, only attorneys, real estate licensees and mortgage brokers can legally negotiate short sales for others for profit. Yet many of these third-party operators forge ahead without any license, hoping to remain undetected. A few months ago, a representative came to my office to promote his company, and to drop off business cards and brochures. He said to me that his company does not technically “negotiate” short sales; they only “facilitate” short sales. Violation, violation, violation!

A minority of these companies have bothered to expend the effort and expense to become licensed, and granted, that might make them legal in the eyes of Nevada lawmakers. However, some of the ways in which they structure their fees, while maybe legal under the letter of the law, make me very concerned, and in my opinion, break the spirit of the law. Some of them might even be in violation of federal law. And sometimes, though legal, there isn’t any concern for ethics. Let me give some examples.

I recently had the chance to review some of the addenda that real estate agents are using when working with outside companies. In some cases, they say things like if the seller does not or cannot pay for the negotiating service, then the buyer must pay; or, if the short sale lender does not approve of the fees, then the buyer must pay. I saw one that mandated a $1,500 bonus to the negotiating company in the event that they obtained “full satisfaction” for the seller. Who should pay this bonus, and will it be on the HUD? I also saw an addendum that said if the buyer cancels the transaction for any reason, the short sale negotiation company can deduct their fees from the buyer’s earnest money deposit.

As my regular readers know, I am vehemently opposed to a buyer or seller signing company-specific paperwork belonging to another real estate company. In other words: at TRR, we use GLVAR and NRED paperwork, and do not alter those documents in any way. We have a few of our own in-house documents, but only ask our clients sign them. We never ask the client of another real estate firm to sign our paperwork. And I strongly recommend to my agents that they do not allow our clients to sign other company’s paperwork either. They need to put their foot down and flat-out refuse. But I have seen agents, and even brokers, mandate this type of paperwork, and that has acted as an impediment to the transaction, and in my opinion, that constitutes a breach of their responsibility to their own client. Unless their client has given specific instructions to the contrary, no licensee can block a transaction or impede a transaction based on his company’s paperwork requirements. When a real estate company contracts with a preferred vendor to handle their short sale negotiations, and then requires clients of other real estate companies to sign that paperwork, I believe that we are dangerously to close to an ethical problem.

Agents need to be incredibly diligent, and always very carefully read what they are asking their clients to sign. It is possible to unwittingly put their client on the hook for payment to a short sale negotiating company, sometimes outside of closing, even, in some cases, if the company fails their mission and the transaction falls apart.

In some cases, these companies have instructed buyers and/or sellers to pay their fees outside of closing, which is a problem, as well. But one of the most clever things I have seen recently, involves what I consider to be a RESPA (Real Estate Settlement and Procedures Act) violation. And here’s how it works.

In most cases, short sale lenders do not approve payments to short sale negotiating companies. I recently had a conversation with a senior asset manager at Bank of America who confirmed this. Outside companies know this, so they need to find a way around it. They also know that in most cases, short sale sellers are in financial trouble, so obtaining payment from them is difficult. So, they will work closely with the listing agent. Let’s say a buyer makes a clean offer for $150,000 on a property. The listing agent might counteroffer at $155,000, with a $5,000 credit going to the buyer (a credit the buyer didn’t even ask for, mind you). The listing agent will then create an addendum stating that the buyer will pay $5,000 (an amount equal to the credit) to a short sale negotiating company for its services. So, on the settlement statement, it appears that the buyer is the party paying for the service, not the seller. This scenario is more likely to fly under the radar of the short sale lender, they hope, since the payment is not coming directly from the seller.

However, in many cases, the buyer’s lender will never approve this, especially if the buyer is obtaining FHA financing. Furthermore, how soon will it be until the banks catch on to this scheme, and put an end to it? It makes the appraisal process much more of a hurdle, since we are artificially inflating the purchase price. I am not an attorney, but to me, this appears to be mortgage fraud. It certainly smells bad. Isn’t this incredibly similar to what was going on a few years ago, when home prices were artificially inflated in order for cash-back to be split among unethical appraisers, mortgage brokers and others? Isn’t this mortgage fraud to the buyer’s lender?

So, we have the seller crediting the buyer, then the buyer crediting the short sale negotiating company. I have even seen the payment requested outside of escrow, off the HUD, which is, to me, clearly a RESPA violation. It is my interpretation that in order to be RESPA-compliant, all fees and expenses need to be not only listed the HUD, but clearly and accurately identified.

Frankly, whether this is technically legal or just ethically disgraceful, I have a real problem with it. I am calling for all real estate professionals right now to refuse to engage in these practices. Do not allow our industry to be further sullied by these companies!

There should be no secret envelopes delivered to title companies “on behalf of the seller”. There should be no bonus system unjustly rewarding someone for doing their job in the first place. There should be no payments made outside of the HUD. There should be no maneuvering of payments in order to conceal the true recipient of funds. There should be no company-specific addenda that bind parties unfairly and without purpose.

It is my opinion that negotiating short sales is part of a real estate agent’s job. Yes, it’s time-consuming. Yes, it’s difficult. Yes, it’s tedious. But I say: TOO BAD! This is today’s market, and this is what we do. Any agent who cannot handle short sales should reconsider their profession. Short sales are here to stay for the foreseeable future, as I have written many times before, and now constitute more than a third of all listings in the Las Vegas MLS.

Agents who contract with these outside companies are jeopardizing their reputations, playing roulette with their ethics, and possibly, much worse. I seriously discourage the use of any third-party short sale negotiating company. While there might be a few of them that are legal and honest, in my experience, the vast majority are not. And even some of the legal ones have structured their fee system in a way that is unfair, unclear, and in some cases, might be at the least in violation of the spirit of RESPA and other laws.

I am starting to smell new laws, new consumer protections and quite possibly, new paperwork from our governing bodies to specifically address these issues. I, for one, welcome as much oversight as we can get in this regard.

Feedback on this blog topic from attorneys, mortgage brokers, title officers and other industry professionals is explicitly welcome and encouraged.

Date posted: April 3, 2011