Closing costs credits: creative financing or fraud?

Financially stressed buyers often look to their brokers and mortgage professionals to help them make a deal happen. When they can't scrape enough cash together, creative solutions are often proposed. Here's a common scenario:

Buyer agrees to buy and seller agrees to sell. The purchase price is $300,000. Buyer has a down payment of $15,000, can get a loan with a 95 percent loan-to-value ratio, but can’t afford the additional closing costs. Buyer and seller agree to increase the purchase price by $5,000 and seller will give the buyer back a credit of up to $5,000.

The buyer can now borrow an extra $4,750 to cover closing costs at 95 percent LTV. Buyer gets house, seller gets money and the bank is fully informed. Creative financing, right?

Maybe not. Maybe, it’s fraud.

The increase in sales price is not justified by any additional real estate sold to the buyer and the seller did not incur any additional actual costs.

There are two problems with this scenario (at least):

(1) The hazard insurer and the title insurer rely on the purchase price amount in order to determine value. While perhaps disclosed to the originating lender, the arrangement would not be disclosed to the insurers who are mislead by the unjustifiably inflated purchase price.

(2) The unjustified inflation in the purchase price will not be disclosed to the secondary mortgage market (which effects unwitting private banking institutions and public markets through the issuance of mortgage-backed securities).

The FBI this year issued a warning echoing the statutory provisions which, in part, states that “[i]t is illegal for a person to . . . willfully overvalue any land or property . . . for the purpose of influencing in any way the action of a financial institution.”

As I understand it, this is not an uncommon scenario.

Attorneys beware also, at least one state’s supreme court has found a lawyers participation in a deal like this may be unethical.