Buy and Bail, a legal and ethical conundrum. Read this and let us know what you think!
I had posted this article about 10 years ago when we were closing so many short sales, when it was an area of business worth pursuing. It quickly had over a million hits and thousands of comments from Agents and the public alike, it moved to the number one article on Point2Agent. I discovered this article was deleted(boo!) It is a bit outdated because short sales are not a huge part of Agent’s business anymore, but the info is still relevant. This inspired some pretty heated debates, which I found extremely interesting. Okay, now on to the article.
A Buy and Bail is essentially where a homeowner plans to walk away from an underwater mortgage AFTER financing a second home purchase. Only after they close on their new home, do they start missing payments on their underwater mortgage, keeping their credit intact until they have successfully closed on their new home purchase.
Do Real Estate Agents have a responsibility to a Client to represent them on a Buy and Bail, or should they turn work down when they suspect a client might be trying to pull a fast-one on a lender? It is quite clever and strategic. Too clever for many licensed Agents. Additionally, this activity certainly does not help our markets bounce back from a downturn.
Here is how it works in a nutshell. A person owns a home and the mortgage is higher than market value. That person is in a financial position to finance another home, so they make a mortgage application while their credit is in good standing. They close the new sale with the intention of bailing on the home they already own by short selling it or letting the bank take it back by foreclosing.
Result for the sneaky individual. They now own a new home at a reduced purchase price, with a more attractive interest rate. They plan to short sale their first home, but even if a short sale is unsuccessful, they agree to let the bank foreclose. They do not care about short selling or getting foreclosed on because they no longer have such a need for their good credit, as they have already made their new purchase and are much more financially comfortable with their reduced payments.
The legal problem comes into play if the borrower lies on a loan application. Lying on a loan application is loan fraud, which is a BIG no-no! HUGE NO-NO. Some Mortgage lenders ask about the plans for the existing properties when vetting borrowers, but others do not ask this question on the loan application, with the idea that they don’t have a stake in the existing home loan. If the question is asked, that is where loan fraud can be an issue.
The Buy and Bail is most often available to those with big enough paychecks and low enough debt to qualify for two homes, so a Buy and Bail it is not easy to achieve regardless.
Fannie Mae and Freddie Mac identified that the Buy and Bail was occurring, so they initiated some policies that would help lenders identify potential offenders. Red flags would be raised if someone was purchasing a home within a certain radius of their existing home. Many people would prefer to keep their kids in the same school district, or they want to stay in the same neighborhood. The proximity alerts underwriters to require the purchaser to draft a letter explaining why they are purchasing another home so close to their existing home. Additionally, if the borrower were securing an FHA loan, they would be required to come up with a 20% down payment, not the 3.5% for a typical FHA loan. They would also require a minimum of 6 months of reserves in addition to the increased down payment. The reserves need to include the cost of both mortgages. These requirements make the Buy and Bail unaffordable for many.
The problem is that this can be avoided if a person is willing to relocate to a different area. I think the radius that flagged Freddie Mac and Fannie Mae was if you were buying a home within 5 miles of your existing residence.
When I first heard about the Buy and Bail, I googled it and found a large number of Real Estate Agents promoting this type of strategic defaulting. I found this alarming; I was shocked. Agents were openly willing to guide clients through this type of activity. It feels a bit like instructing someone how to rob a bank where they are employed.
We don’t know what a borrower is putting on their loan application OR what the loan application even asks. We don’t know if they are committing loan fraud or not. If a licensed Real Estate Agent is promoting this type of strategic default, are we inviting liability into our business? I still do not know for sure, although I am inclined to believe the answer is yes. I will tell you why I remain unsure.
My local area has classes that attorneys put on for Realtors. It is part of the service the local board provides its paying members. The attorneys had no concerns about the Real Estate Agents liability if a Borrower elects to get foreclosed on strategically. An Agent will likely discover that they are scheming to Buy and Bail when they receive a call to list their first home as a short sale soon after the closing. However, it seems particularly risky if a Real Estate Agent is promoting this activity as a way to gain clients, and guiding them through the process.
What if a potential Client tells us their plan to Buy and Bail? Are we obligated to back out of the deal, or do you then insist on seeing the borrower’s loan application to ensure that Buyer’s particular lender is not asking what the borrower plans to do with their existing residence?
My position is that I will not be promoting myself as a Buy and Bail Agent, now or in the future. I wrote this article after I unwittingly became a participant in a Buy and Bail. It remains unconfirmed that this was my Client’s intention when they put an offer on a home close to one they owned. They told me they wanted to take advantage of lower prices and keep their existing home as a rental. Six months later, they called me to list their home as a short sale. We successfully short sold their home and their lender did not report negatively on their credit. If it was their intention to Buy and Bail, this worked out very well for them. Frankly, it worked out well for me too.
I entered into this situation not ever hearing of a Buy and Bail. Now, I hope to let other Agents know that this is something that we might see in down markets.
What do you think, is the Buy and Bail and reason for Agents to hit the pavement and run OR an opportunity?