Short Sale Fraud: Scams to Avoid

If you're having difficulty paying your mortgage, you might be considering a short sale. Avoid these common scams.

Updated by , Attorney · University of Denver Sturm College of Law

If you're having difficulty paying your mortgage, you might be considering a short sale of your home. A "short sale" is a property sale where the sale proceeds are less than the balance owed on the mortgage loan.

Short sale fraud schemes come in different forms, but a few are more common than others. Short sale buyers and sellers should watch out for the following scams.

Undisclosed ("Outside of Escrow" or "Off the Settlement Statement") Payments Scam

Lenders approve short sales to avoid foreclosure and minimize their losses. Before giving their approval, lenders often do one or more of the following:

  • Reduce commissions to real estate agents.
  • Require that sellers receive no financial benefit from the sale.
  • Reduce or even disapprove payments to other parties involved in the short sale (for example, short sale negotiators, attorneys, etc.).

Primary lenders will also cap payments to junior lenders. If more than one loan is on the property, the short sale won't go through without junior lienholders releasing their liens. To get releases, the primary lender will allow some of the short sale proceeds to go to the junior lenders. But it will set a cap on these payments.

As you can imagine, those receiving reduced or capped payments are often unhappy with this situation. Taking advantage of highly motivated buyers or sellers, these junior lienholders might request payments "outside of escrow" or "off the settlement statement." As a buyer or seller involved in a short sale, you might be tempted to make an undisclosed payment just to get the deal done. By doing so, however, you would most likely be a party to loan fraud.

All payments made as part of a short sale transaction should be disclosed to the lenders and other parties approving the short sale. According to Freddie Mac, short sale fraud occurs when someone deliberately misrepresents a fact or omits a fact to induce a lender, investor, or insurer to agree to a short sale that it would not have approved if it had known the truth.

How do you know whether a particular payment would have affected a lender's decision to approve a short sale? You don't. To be safe, disclose.

"Flopping" Scam

"Flopping" happens when a short sale lender approves a short sale based on a misrepresentation of the property's value. In a typical flopping fraud, the fraudster is the buyer purchasing the property from the short sale seller. In some cases of flopping, the seller's real estate agent is the buyer.

The fraudster presents a low purchase offer for the property to the lender, along with an artificially low property valuation, to convince the lender that the property is worth less than it really is. Meanwhile, any higher offers from bona fide buyers are withheld from the lender because the lender would most likely reject the low offer if it knew that higher offers were on the table.

Once the lender approves the short sale at the artificially low price, the fraudster contacts a bona fide buyer or markets the property at its true market value. Without the short sale lender's knowledge, a second escrow between the fraudster (as the seller) and a bona fide buyer is then opened to close simultaneously with the first purchase or soon afterward. The perpetrator of the fraud buys low, sells high, and keeps the difference between the two sale prices.

Flopping can also hurt sellers (the original mortgage borrower) because the lender might hold the seller responsible for the deficiency (the amount of the difference between what the seller owed and the sale price). If a lender forgives a seller for the deficiency, the seller might owe taxes on the amount of forgiven debt.

Predatory Short Sale Negotiators Scam

Sellers considering short sales are particularly vulnerable to con artists hoping to take advantage of their stressful situations. These con artists, calling themselves "short sale negotiators" (or "short sale processors," "short sale coordinators," "short sale expeditors," "debt negotiators," "debt resolution experts," "loss mitigation practitioners," or "foreclosure rescue negotiators") guarantee results for a flat fee or a percentage of the sale price. Oftentimes, the short sale negotiator takes the fee and does nothing or little in return.

Some statesincluding California, Washington, and Oregonrequire short sale negotiators to be licensed by the appropriate state agency (most likely the agency responsible for licensing and regulating real estate agents). If you're considering hiring a short sale negotiator, contact your state's agency to find out whether short sale negotiators need to be licensed and, if so, whether the short sale negotiator you're planning on hiring is indeed licensed.

In California, it's generally illegal for short sale negotiators to collect fees before providing services unless specific requirements are met. You should also check if this is the case in your state.

Before hiring a short sale negotiator, do your due diligence. Read documents carefully before signing. Ask questions. Ask for and contact references. Seek the advice of an attorney or another neutral third party. If it sounds too good to be true, it probably is.

The No-Short-Sale Scam

In this kind of scam, a business calling itself a mortgage company or something similar offers to buy your home in a short sale, using the supposed purchase money to pay off the lender. You sign the home's deed over to the company. The company then convinces you that it will deal with the loan servicer (for one reason or another) and that you should move out because the lender won't approve a short sale unless you do.

Then, instead of paying the lender, it turns around and sells the house to an unsuspecting buyer or rents it out, pockets the proceeds, and disappears when the lender moves forward with the foreclosure. You're not only out of your house but paid nothing to the lender and still owe the entire mortgage balance.

What to Do If You're the Victim of a Short Sale Scam

When putting together a short sale, make sure you're dealing with a reputable real estate company and your loan servicer. You should also be getting guidance from a HUD-approved housing counselor.

If you are a victim of a short sale fraud scheme or another foreclosure rescue scam, contact

  • the Federal Trade Commission (877-FTC-HELP)
  • your state attorney general's office, and
  • your local Better Business Bureau.

By reporting a scam, you might be able to help someone else avoid becoming a victim.

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