In April, 2001 newsletter, Investors Title republished an article by Lynn W. Wilburn entitled "Flip!" Not Just Another 4-letter Word Illegal Flip Real Estate Transaction which pointed out the dangers and in some cases potential criminal aspects of "flip" transactions.
Real Estate attorneys now have additional reasons to be vigilant to identify a "flip."
The Department of Housing and Urban Development (HUD) has published its final rule regarding "flipping" which is effective June 2, 2003 and is an addition to 24CFR203.37.
The HUD rule governs the ineligibility of loan transactions for Federal Housing Administration (FHA) insurance where they fall within certain parameters with respect to timing of sequential transfers and increases in the sales price from one transaction to another.
The action by HUD is clearly aimed at curbing the fraudulent practices which have become all to prevalent in recent years by which the value of the property is artificially inflated on resale so as to qualify for a larger loan. To the extent that any "flipped" loans are insured by the FHA, that agency is exposed to losses which would be avoided if the sales price was bona fide.
The rule sets forth specific time restrictions on the period of time between the date that the seller acquired the property (referred to as the date of settlement in the rule) and the date of execution of the contract of sale to the new buyer and borrower (Resale Date). They are:
1. 90 Days If the resale date is not more than 90 days from the date of acquisition by the seller the property is not eligible for FHA mortgage insurance. It is interesting to note that the original proposed rule made ineligible any resale within six months of acquisition but provided for case by case exceptions. Although the final rule reduces the period to 90 days it is absolute and subject only to limited exceptions for certain REO or relocation property explained below FHA insurance is not available for transactions within this time frame even if the resale price can be substantiated.
2. 91 to 180 Days If the resale date is 91 to 180 days from acquisition the loan is eligible for FHA insurance, but if the resale price is 100% over the original purchase price FHA must receive a second appraisal substantiating the increase or satisfactory documentation of improvement/rehabilitation of the property to justify the increase.
3. 91 Days to 12 Months During this period, a resale is generally eligible for FHA insurance. The rule further provides "However, HUD may require that he lender provide additional documentation to support the re-sale value of the property if the re-sale price is 5 percent or greater than the lowest sales price of the property during the preceding 12 months (as evidenced by the contract of sale). At HUD's discretion, such documentation must include, but is not limited to, an appraisal from another appraiser. HUD may exclude re-sales of less than a specific dollar amount from the additional from the additional value documentation requirements.
There are very specific, limited exceptions to these holding period restrictions. The following transactions are not subject to the resale time periods stated above.
1. Sales of Real Estate owned (REO) properties by HUD and sales of properties in revitalization areas pursuant to the National Housing Act (12 USC 1710 – Section 204).
2. Resale of properties by an employer (or relocation company) in connection with employee relocation.
The new HUD rule on "flipping" creates an additional underwriting burden for those lenders intending to obtain FHA insurance; however, it is also significant to the real estate attorney who closes loans.
The simple fact that the situation with flipping has commanded the attention of HUD and moved it to further regulate the requirements for eligibility points out the prevalence of the practice and the consequences that agency sees (1) for the individual consumer who may be preyed upon, and (2) the fraudulent practices in loan origination are being employed which ultimately are funded by government insurance.
More importantly, for the closing attorney acting as settlement agent, there is potential liability if the lender's closing instructions either directly requires that the loan qualify for FHA insurance or generally requires compliance with federal regulations. In such cases, the lender may assert liability against the settlement agent if the loan does not qualify. Moreover, liability for failure to comply would fall outside of the coverage provided in the standard ALTA Insured Closing Protection letter. Insured closing protection is limited to failure to comply with the lender's written instructions to the extent that they relate to… "the status of the title to said interest in land or the validity, enforceability and priority of lien of said mortgage on said interest in land."
Title is not the issue in "flipping", it is the timing of the transaction and the valuation of the property.
The new HUD rule is only one more red flag warning the settlement agent of the dangers of flipping. There are many other sources of potential liability whenever the transaction is made to look like something it isn't. So, BEWARE!