Short sale home to family OK?

2 min read

Dear Real Estate Adviser,
I want to sell my house in a short sale. I haven’t had to sign an arm’s-length agreement, so can I sell to a relative?
— Abdul H.

Dear Abdul,
While the sort of selling scenario you envision does happen, it’s undesirable if not downright illegal in most lending and regulatory circles because of the potential for mortgage fraud. Moreover, government or government-related entities HUD, FHA, VA, Fannie Mae, Freddie Mac and the FDIC are cracking down on the practice. They’re even going back and examining past deals where relatives may have profited.

Although you haven’t been asked yet to sign what’s called an “arm’s-length affidavit” — an assurance that sellers and buyers are unrelated and are bargaining only in their own self-interests with no side agreements — doesn’t mean you won’t have to sign one if your bank approves your short sale. Why waste all that time?

Ask if it’s OK

You’d be well-advised to be transparent and just ask the bank about the potential for such a sale before you proceed. If you wait and a conflict emerges later, the bank may not only nix the deal, it may even report it to the feds if it suspects you or the related party is trying to secretly profit.

What HUD prohibits

If your intent is to stay in the house with the related buyer as your landlord, arm’s-length provisions also state that buyers can’t buy or rent the property back to the seller.

The Department of Housing and Urban Development issued this clarifying statement in 2013: “A pre-foreclosure (short sale) must be between two unrelated parties and be characterized by a selling price and other conditions that would prevail in a typical real estate sales transaction. Any conflict of interest, appearance of a conflict or self-dealing by any of the parties to a transaction (borrower, lender, appraiser, purchaser, etc.) is strictly prohibited.”

One of the reasons for this is that some HUD short-sale programs fully satisfy the seller’s debt even if the proceeds don’t satisfy the mortgage balance; hence, they don’t take kindly to in-arrears sellers or chummy buyers profiting in the process.

Other options exist

Alternatively, your relative may be able to:

  • Buy your house at auction for cash, although the lender will likely just run up the bid to the amount they’re owed including all fees and arrearages.
  • Buy your house after the lender forecloses on it and puts it on the market, although this will cause a worse blemish on your credit.

In both scenarios, your relative might be better off paying your mortgage debt in return for you quitclaiming the deed to him or her.

Sure, the type of non-arm’s-length transaction deal you’re considering can still occur when related parties play dumb, say agents who handle short sales. But I wouldn’t risk it.

The long and short of it: It’s best to play short sales straight. Good luck!

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