Creative Financing Has Its Limits; You Should Recognize Yours

Ray J. Michalowski, Esquire

Revised: Brett M. Woodburn, Esquire

"Creative financing" is a term often used to describe the methods used by sub-prime lenders and mortgage brokers to provide mortgage loans to consumers who might not otherwise qualify for them. This "creativity" may take the form of interest-only loans, loans combined with grants and/or seller payment of buyer closing costs. The recent changes in the market have affected the sub-prime mortgage lending market and what lenders are willing to do, but that does not mean that the less-than-scrupulous mortgage brokers won't still try to bring new buyers into the market and try to expand the range of homes available to such buyers. Moreover, with short sales becoming more and more prevalent, builders, developers, investors, and homeowners will be far more anxious to do what they can to sell their property. Inevitably, many REALTORS® will work with a buyer that has shaky credit, or a seller who is coming up "short," and will question whether or not some of the "creative" lending practices they see are legal.

Changing the sales price on an executed agreement of sale is the creative financing trick that most often vexes callers to the PAR Legal Hotline. The scenarios that are presented to the Hotline attorneys differ greatly, hence why it is called "creative" financing, but usually involve increasing the sales price on the agreement of sale to allow for additional seller closing cost assistance.

While the circumstances of the price change vary with each call, the bottom-line question is always the same: "Is this legal?" The callers are usually less than satisfied with the lawyerly answer that always follows: "It depends." This answer should immediately clue to the caller into two things. First, the caller was right that this is a question that needs to be answered by an attorney. Second, the one thing the caller must do is refer their client to the client's own legal counsel to get the question answered. REALTORS® often have a working knowledge of the mortgage loan industry, but evaluating the legality of alternative or creative financing is usually beyond your scope of practice and expertise.

Changing the sales price on an agreement of sale is not, as many callers think, de facto mortgage fraud. Nor does the fact the mortgage lender or mortgage broker supposedly "approved" the price change make it legal. A mortgage broker doesn't even work for the lender; their primary duty is to the borrower. A request to increase the selling price of a home already under contract should raise some questions. While there is no single, "bright-line" test to tell whether the request is legitimate, there are several methods available to reduce the risk to both the agent and the client:

1. Never agree to increase the list price in the MLS solely for financing purposes. This "revisionist history" practice is an extremely dangerous one. There is never a valid reason (trying to fool an appraiser or underwriter is NOT a valid reason) for this and it puts you at immense risk as an active participant in the scheme.

2. Changing the price without disclosing the change to the lender is never a good idea, but it is a good way to commit mortgage fraud.

3. Increasing the price to allow the seller to take a "phantom" second mortgage that will quickly be forgiven after closing, is extremely dubious.

4. If a mortgage broker or lender asks you to do something that seems improper, ask them to put the request in writing. If they won't write it down, you shouldn't do it.

5. If you feel uncomfortable with any financing approach offered to your client, don't give your best guess as an opinion, or practice law without a license. You were hired to find a house or a buyer, why take on liability you are not being paid for. Suggest that the client seek counsel and do so in writing. Seek your own legal counsel as needed, and limit your participation in the transaction if necessary, to protect your license, reputation and livelihood.

Now more than ever, transactions are being examined with a careful eye. We are all well aware of the impact that the lending practices of the preceding decade has had on today's market, and the economy as a whole. Are you anxious to put yourself in the cross-hairs?