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How do Real Estate Flipper Schemes Work?

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Using Straw Buyers in Flipping Schemes is Against the Law

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Question: How do Real Estate Flipper Schemes Work?
A reader asks: "We're buying a bank-owned home that our real estate says was involved in flipping. It this a bad omen? My husband is worried that this will flipping will backfire on us, but I think it's behind us since the bank now owns the home. How do real estate flipper schemes work?"
Answer: You are correct. If the home was flipped by crooks and went back to the bank, the flipping scheme won't involve you. In fact, you are probably buying this bank-owned home at a very good price.

Buyers for a home in the Pocket area of Sacramento bought an REO last fall. It had originally sold for $50,000 more than list price and had been rented before the bank foreclosed. After checking the transaction history of this home, it appeared the agent -- who was also the mortgage broker -- most likely obtained an inflated appraisal. He sold the home to a relative who then rented it out and never made a single payment.

The buyers picked up this home for almost half of its original sales price and way under market value. For added protection, make sure you get a title insurance policy to protect your interests in this home, but once title has been transferred to the bank via a trustee's deed in a foreclosure, all liens are cleared.

There are many ways a flipping scheme can work. The above example illustrates one way to do it, but there are other scams perpetrated in real estate, one of which involves straw buyers (a buyer who isn't the real buyer).

Flipper Schemes With Straw Buyers

Not all flipper houses involved schemes. For example, buying a flipper house from an investor who bought a fixer upper and made improvements is common in some neighborhoods, and the investor most likely has not broken any laws. Flippers got a bad rap over the years, most recently during the real estate boom of 2000 to 2005, because some mortgage brokers and agents were in cahoots with crooked investors. This is one of the ways that flipping schemes worked:

  • Parties to a Flipper.
    Flipping involved four parties: the appraiser, the investor (or real estate agent), a mortgage broker and a straw buyer -- all four knew each other.

  • Flipper Investor.
    The investor would make a deal with a seller to buy the home at a bargain-basement price. Typically, the seller was not really involved in the flipping scheme but was instead a victim.

  • Flipper Straw Buyer.
    The investor would then pay a few thousand to entice a straw buyer to purchase the home at a value much higher than market value. The straw buyer typically had a good credit rating but insufficient income.

  • Flipper Appraiser.
    The appraiser was instructed to appraise the home at its inflated value and present this fake appraisal to the mortgage broker.

  • Flipper Mortgage Broker.
    The mortgage broker packaged the loan for the straw buyer, relying on "state income" (made-up income) documents, and the deal closed.

  • Flipper Profits.
    The straw buyer, appraiser, mortgage broker and investor then divvied up the proceeds among themselves, with the bulk of the profit going into the investor's or agent's pocket.

  • Flipper Resale.
    Then the investor put the home on the market and sold it to a real buyer, letting the straw buyer sign the deed over to the new buyer. Typically, the new buyer did not show sufficient income, either, but regardless, the same mortgage broker qualified the buyer.

  • Flipper Foreclosure.
    A few months after closing, the new buyer goes into default on the loan. By this time, the original parties are long gone to Tahiti, and the home goes to foreclosure.

Due to the extent of this type of flipping, regulators have cracked down. Appraisals are scrutinized closely nowadays, and lenders have tightened guidelines for loans. The FBI closely monitors mortgage fraud and lots of crooks have gone to jail.

At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.

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