Buried in a new Consumer Financial Protection Bureau proposal is a new effort to control illegal flipping.
On its face any effort to limit illegal flipping should be seen as a good thing because the practice of illegal flipping hurts not only buyers and lenders, it also knocks down community values once such properties inevitably are forced into foreclose.
Illegal flipping is typically a quickie real estate transaction which involves fake appraisals and falsified loan documents. While there is no law against “illegal flipping” there are laws against mortgage fraud and mail fraud which can be used to prosecute such transactions.
In 2003 HUD enacted an anti-flipping rule which said that FHA financing would be unavailable for most homes that have been resold within the past 90 days. This was an effort to get at the heart of the illegal flipping problem, but it also created a lot of collateral damage. It meant buyers could not get FHA loans to purchase homes from legitimate rehabbers and investors who quickly fixed-up properties for re-sale — and didn’t cheat the system.
In 2010 HUD waived its anti-flipping requirement and the result was that in fiscal 2010 and 2011 the FHA insured nearly 42,000 loans that would not of been made under the original 2003 rule. At this point HUD’s anti-flipping rule has been waived through the end of 2012, however other lenders who adopted the HUD rule at some point since 2003 have generally not waived the standard.
Now the CFPB has come out with a proposal requiring that borrowers receive an appraisal three days before closing for any property financed with a “higher-risk” mortgage. In addition, a second appraisal will be required if the property has been resold for lower value within the past 180 days — in other words, buyers will be unable to finance homes with jacked-up prices and insufficient value, the very definition of an illegally-flipped home.
Borrowers who take out a higher-risk home loan pay subprime mortgage rates (if not worse) than those able to finance with a “qualified residential mortgage” such as FHA, VA, or conventional financing. And, of course, they are the most-likely borrowers to face foreclosures or a short sale.
The Bureau’s proposal is a step in the right direction but does not go far enough.
First, it does not apply to all borrowers, just those getting higher-risk mortgages.
Second, what is the practical value of getting an appraisal three days before closing? Will the borrower have enough time to get replacement financing from a different lender? And what if the borrower decides not to go through with the transaction because the appraisal report shows that the sale price is grossly too high? Without proper contract language, backing out of the deal could mean losing a deposit and possibly facing a seller lawsuit.
How about a more sensible standard — say electronic transmission of a completed appraisal to the borrower within 24 hours of receipt by the lender? In other words, just forward the appraisal report to the borrower by email. This way the sale could be contingent on an appraised value satisfactory to the buyer.
The CFPB has the right idea but it can do a lot better than the proposal which has been put on the table.