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By CathCoy
March 30, 2007

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When we sold our home last year, we gave the seller a significant amount of cash back -- more than $50,000. The sale price was recorded as the sale price + the cash back, rather than just the amount the house truly brought in.

If the lender ever finds out about this, they'll call the loan due. No doubt this was a behind-the-scenes scheme, which means that the value of the home, as you said, is inflated by the cash back deal. Here's what Fannie Mae has to say about such schemes (stated as a hypothetical).

***

Q: We've looked at houses to which we'd do immediate work. For us to pull it off, though, we'd have to get a seller's concession. Pay an extra $10k for the house and have the seller kick back $10k into the escrow account to pay for the renovations. This way, the renovations get wrapped into the mortgage, and cost very little extra out of pocket.

A: It doesn't work quite that way. Per Fannie Mae guidelines, only certain seller concessions are allowed:

Section 203.01 We limit the amount of contributions by interested parties that can be included in any given transaction, although not all contributions are subject to this limitation. Specific types of contributions and whether or not they are subject to our limitations are discussed below:

[Basically, seller contributions are limited to recurring and non-recurring closing costs, not "kick-backs," even if the kick-back is used to improve the property.]

In some cases, seller contributions--such as decorator allowances, repair allowances, moving expenses, a payment of various fees on the borrower's behalf, "silent" second mortgages held by the property seller, P&I abatements, and other contributions not disclosed on the HUD-1 Uniform Settlement Statement--are given to homebuyers outside of loan closing. These undisclosed contributions tend to reduce the effective sales price of the property; therefore, they may compromise the loan-to-value ratio for a mortgage. Consequently, mortgages with undisclosed seller contributions are not eligible for delivery to Fannie Mae. Lenders must assure that their origination, processing, underwriting and closing staffs are knowledgeable about ways to detect undisclosed contributions.

A better way to get the money for renovation after COE (close of escrow) is to have the seller pay all your recurring and non-recurring closing costs up to the limit allowed:

3% of the lesser of the sales price or appraised value, if the loan-to-value ratio is greater than 90% and the property will be occupied as a principal residence;

6% of the lesser of the sales price or appraised value, if the loan-to-value is 90% or less and the property will be occupied as a principal residence.

Having the seller pay your recurring and non-recurring closing costs conserves your own capital that may then be used for renovation after COE.

If you disclose seller's non-allowable contribution, the loan amount will be reduced, dollar-for-dollar, by the contribution.

Why is this, you wonder?

Many people will try to write into a contract a sum of money to be credited for non-specific repairs or repairs that are cosmetic in nature (i.e. $3,000 carpet allowance; $2,000 window treatment allowance; etc.). The major secondary funding sources (Fannie, Freddie, HUD/FHA, etc.) have learned some hard lessons from these kinds of concessions. The lessons were usually learned in the foreclosure process (or after) when none of the things of this nature were in the home when they got it through foreclosure or, if it was, it didn't add any material value. So they (the secondary marketing sources) decided they weren't going to finance any of that stuff.

Termite repair is a beast of a different color. Termites materially affect the quality of the lender's collateral (the house), and the treatment of known infestations will be mandatory. If the loan absolutely must close before treatment is effected, then they will require that 150% of the estimated cost be held in escrow to be used to pay for said treatment. If any of the amount is remaining after all related bills have been paid, the excess will be returned to the party who put up the escrow money. They also have speed- of-completion guidelines. Most lenders don't have the back office support to bird-dog this post-closing escrow stuff, so they usually won't close until the repairs are done.


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