There has been concern throughout the real estate industry over property values that appear to be artificially inflated through creative financing techniques in transactions. The parties may agree to increase the purchase price by an amount that is offset by the seller's agreement to provide credits, pay points or give other financial assistance. The result is properties selling above market price and above the price originally agreed to by the parties during initial negotiations. Increased purchase price values permit buyers to obtain more favorable financing, but the buyers are left with higher assessed values, higher property taxes, potentially higher insurance costs and higher mortgage payments. When appraisers and assessors use this data from these seller-assisted transactions to establish values for other properties, there is a domino effect and the inflated sales prices may be used to unintentionally over-value other properties.
The Wisconsin Department of Revenue (DOR) has taken steps to flag transactions where seller-assisted financing is used and where additional analysis may be needed to determine the "true fair market value" of the property in the transaction. The November 2003 and March 2004 editions of the Real Estate Transfer News (RETN) published by the DOR, included the following question and answer item:
"Q. I am selling my house and am giving back a "second mortgage" which may or may not be forgiven. How is the transfer form filled out for Section VII. GRANTEE'S FINANCING, Line 44?
A. More than one box must be checked. Check the box 'Obtained from seller' and any additional box as to where the primary financing is obtained. In addition to a 'second Mortgage,' any type of 'financial arrangement' from the seller such as 'credit,' 'gift,' 'donation' etc. must have the box "Obtained from seller' checked in addition to any other box where the balance of the financing is obtained."
The Instructions for Wisconsin Real Estate Transfer Return (PE-500a R. 12-03) and the Register of Deeds Criteria for a Completed Real Estate Transfer Return (PE-100 R. 12-03) have been modified to require the disclosure of any type of seller financing: "(44) Grantee's Financing; at least one box must be marked. NOTE: If any type of financing is provided by the seller (credit, gift, donation to nonprofit/charity, land contract, etc.) the box 'Obtained from seller' MUST be checked along with any other box describing other financing obtained by the buyer."
When assessors review the transfer return and see that seller financing was involved in a sale, they can investigate further and employ a cash equivalency analysis to determine whether financing conditions had an effect on the sales price. If price was impacted the assessor must determine the amount by which price was altered and adjust for this modification when assessing property.
Samples of artificially inflated values
- Facts: A broker received a call from a lender who is going to make a loan in the amount of the $79,000 appraised value rather than the $72,000 offer price. The lender wants the broker to rewrite the offer for $79,000 and wants the seller to give the buyer $7,000 back at closing. Artificial Increase of $7,000.
- Facts: A licensee prepares an amendment that provides for a $10,000 roof repair credit and shares the amendment with the lender. The lender instructs the title company not to put the credit on the closing statement. Artificial Increase of $10,000.
REALTOR® practice tip
REALTORS® should always encourage the proper completion of the Real Estate Transfer Return to indicate if any seller-assisted financing or concessions were involved in arriving at the final sales price. REALTORS® also should always complete any similar items for seller credits or concessions in MLS reports so that brokers and appraisers can be alerted to transactions where the sales price may not accurately reflect market value.
Concern about phantom equity and inflated values may arise in transactions where it is suspected that mortgage fraud against the secondary market is being committed or where the numbers are being stretched to enable a buyer to achieve more favorable loan terms. Mortgage fraud occurs anytime a participant in a real estate transaction misrepresents facts with the intent to bilk another party of money it is not entitled to. Fraud may occur when there are two sets of offers drafted, one representing the "real deal" and the other representing the fraudulent transaction. Fraud can also occur when the parties have artificially inflated the sales price in order to create or enlarge the down payment. Typical strategies may include a "forgivable" second mortgage, phony work orders or seller credits. For additional information about combating mortgage fraud, see www.wra.org/fraud.