Is Flipping Real Estate Illegal?
Many people wonder…is real estate flipping illegal? Newbies often want the answer to this question, as well as experts. Flipping real estate brings up a lot of questions concerning legality. There are many myths. Keep in mind that this article does not provide legal advice, and you should talk to an attorney regarding specific questions. If you want to become a creative real estate investor, this article is definitely going to help you understand about house flipping, and the legality of it. You’ll likely read things here that will surprise you; things that you’ve heard the opposite of.
Real estate flipping can make you a lot of money, but know that the real estate industry itself is very regulated, and there are many legalities that you need to understand before getting into a deal (or one that you are currently in the middle of).
First, what exactly is house flipping? Well, when you flip a house, you’ve got to get that house under contract for below retail value. Then, you’ve got to re-sell it to a buyer for a higher price than you paid, in a short time-frame.
There are instances where you’ll need to renovate or repair the property before selling it. Other times, you may not do anything to the house, and simply give your interest in the property to another real estate investor.
What’s the catch?
Now let’s examine how illegal flipping usually works. An investor buys a fixer upper. They usually do not buy it at an appropriate discount. They also typically do a subpar rehab to the property. Then, the investor lines up a naive buyer (although oftentimes the buyer is in on the scheme too), an appraiser, a mortgage broker, and a closing agent. The investor conspires with the appraiser to artificially inflate the value of the home and the closing agent facilitates the transaction, oftentimes giving the buyer a “kickback” for their cooperation in the scheme. In fact, all parties usually get a piece of the fraudulent gains.
This begs the question…”Is it illegal to purchase something at a low price, only to re-sell it to somebody else for a higher price?” This is a perfectly normal question. Some call this arbitrage, which is the process of purchasing at one price then re-selling it for higher. People do these things all the time with everything, not just real estate. Think about eBay, even. Somebody will see some great finds, but them on sale then sell at retail value online. But, when it comes to real estate, there are actual laws regarding flipping houses. Many might use the argument that house flipping forms our economy.
“Seasoning of title”
However, it is important to understand that due to these fraudulent schemes committed by a small number of individuals, lenders were forced to initiate ways to protect themselves from fraudulent transactions. One of the ways they did this was to require what is called “seasoning of title” before they would consider lending money on a property. Title seasoning is the length of time a particular lender will require for a seller to have been on title to a property before the lender will fund the transaction for the buyer. The extent of “seasoning” required by a particular lender varies, but is usually between 3-12 months. As a result, many conventional retail lenders have strict requirements regarding how long a seller must have “seasoned” title.
Flipping Real Estate Myths
Though the internet is incredibly useful, and we are so lucky to have it, the information on it can bring up some misunderstandings. There are many myths that people think are real regarding flipping houses. Here are some of the myths and what you need to know about them:
▪ 90 Day Anti-Flipping Rule:
This is actually not a law by any means. It is merely an “underwriting stipulation.” This stipulation was placed by mortgage companies or mortgage loans that require the seller of a specific property to have been the owner for at least ninety-days. The loans most notorious for placing this requirement are Federal Housing Association (FHA) loans. However, the ban has since been removed. Many mortgage lenders don’t require that you own the house for at least ninety days. However, while there may be one that does, many of them don’t. Yet investors frequently assume that this is real. As such, they believe they have to hold onto the property for a full ninety days before they can re-sell it. Don’t listen to this garbage. It simply isn’t true.
▪ Only Licensed Real Estate Agents Can Flip Properties:
This is not true to a certain extent. Each state has specific laws that describe in detail which activities require a real estate license to perform. Some are a little terrifying; especially if you are new to the business and are very frightened that you’ll do something illegal without meaning to.
These laws also contain exceptions, which you should read carefully. Some of these exceptions allow a non-licensed realtor to perform things that you’d otherwise believe you couldn’t without a license. Therefore, you should read the laws carefully, because there may be things you can do that you otherwise thought you couldn’t. Though, if a homeowner is in foreclosure, you will more often than not need a real estate license.
Where, might, be flipping real estate considered illegal?
When you Option a house and sell it, the end buyer is responsible for their own financing, no “fudging” on your part, and no possibility of fraud. The buyer agrees to pay a certain amount, and has a down payment and credit to match, and knows the deal. The haven’t been misled, and you haven’t helped anyone commit fraud.
Here’s what some people consider “flipping”: They’ll buy a house, or even just contract it, and then turn around and sell it to an unsuspecting homebuyer or Investor, often from out of town or with no Real estate experience, and usually with no money down or for very little down. Next, they’ll bribe an appraiser to give a fictitious appraisal, much higher than the true comparable sales. They’ll work with a mortgage broker who will show the borrower how to submit false documents to the mortgage lender to qualify for a loan they often can’t afford.
Then last but not least, they’ll forge the closing statements from the Title Company to show a down payment and/or closing costs coming from the borrower, in order to get the bank to fund the deal. Is this what you consider “Flipping”? Bribing appraisers and falsifying loan documents and paperwork? If so, then you’re right, it is illegal. But when you “Flip” a house by selling it for retail price to a retail buyer, who works with a legitimate appraisaer and Mortgage Broker and gets their own financing, with no “funny stuff,” there’s nothing even slightly illegal or grey about it. It’s simple and easy, with no B.S.
Each state in the US has certain laws regarding real estate flipping. Some are stronger, and more specific than others, depending on the state. While house flipping has gotten a bad reputation in the last few years due to a few bad apples, it is still a great way to get into Real Estate Investing if you know what to watch out for. Done properly, house flipping is legal, moral and ethical, and is a great way to invest in real estate wiothout tenants, rehabs, or risk.
For those wanting to get involved in the house flipping business, they should be aware that there are shady characters in the business. This has led the Federal Housing Administration (FHA) to tighten regulations on quick reselling of houses. There are also many regulations governing real estate and many of the functions of buying or selling a house require a state license.
Probably the most closely watched legal issue with regard to house flipping is mortgage fraud. Under these schemes, a house is bought and appraised at a greatly inflated price. It is then sold to an unsuspecting buyer for much more than it is worth. As a result, the buyer is more likely to default on the mortgage, and the issuer of the mortgage loses money.
There also are many people out there who are more than eager to take advantage of someone who wants to buy or sell a house with the intention of flipping it. For the seller, this is particularly cruel since most likely they are selling because of a financial problem. Their problems become compounded by someone who takes advantage of them by offering to help, then skimming off what little money the seller has left.
In such cases, the unscrupulous “agent” will read through public records to see who has filed bankruptcy or whose house is in foreclosure. They will approach the person with the offer of help, either from an expert who will negotiate with the mortgage company, or a “buyer” who is willing to purchase the property. They will get the seller to sign a contract at which point it just so happens that the expert is either unable to help as expected, or else the buyer backs out, and the shady agent keeps his commission. The person looking to sell is left in even deeper financial woes.
It’s extremely important for real estate investors to keep accurate records so they can document the transaction. A smart investor will be able to show proof that they bought the property at a discount from a motivated seller and that the property needed work (evidenced by a listing sheet and before photos). They should also have proof that a legitimate rehab was performed (evidenced by receipts and invoices). When armed with this documentation, investors are able to support the increased sales price in such a short amount of time. In some cases, the lender may decide this documentation is enough to waive their seasoning requirement, and they may require a second appraisal to be sure. In other cases, lenders may not bend on their seasoning requirement no matter how much documentation is provided. In that case, it may be necessary for the investor to bring the buyer to a lender who has no seasoning issues.
Again, For many, house flipping is a way to make a lot of money, quickly. As with any “get rich quick” scheme, there are many people in the business looking to take advantage of someone. Even perfectly legal house flipping can run afoul of the law unintentionally, especially since government and law enforcement agencies are now keeping a closer eye on the practice.