Friday, August 10, 2007

Sale Price Inflation Revisited

A while back I did a post on how the sale price of a house can be inflated by giving cash back to the buyer at closing. This makes overall market appear to be holding up much better than it really is. In fact, when we sold our townhouse in Virginia to move back to California, almost all the comparable sales had subsidized the borrowers (I'm sure this was also related to the fact that our development was entry level homes, so first time borrower's didn't have the cash for down paymenta and closing costs). This phenomena was rare back in 2002 when we bought. On an aggregate level, I think it makes the RE statistics look much rosier than they really are, particularly at the lower end.

Based on the comments from my earlier post, I found out this doesn't typically occur in California the way it does in Virgina. Although I did see a post a while back on OC Renter's Blog highlighting this activity as fraud. However in that case, $40,000 is a lot more than just closing costs.

Most likely, it doesn't occur in California because the buyer pays taxes on the purchase price of the house, so there is an incentive to make that purchase price as low as possible. In Virginia you pay taxes on the assessed value of the house, so a couple thousand added on to the purchase doesn't do any harm to the buyer. In both cases the seller does have to pay RE commission on it, but in this market, they are lucky to even have buyer with a GFE.

10 comments:

Sippn said...

Good point but in CA you also pay based on the assessed value - most of the time the assessor bases it on the purchase price.

The Sac county assessor has assessed some properties below purchase price due to the market.

Gwynster said...

The trick with those cash back deals is that money is suposed to pay for the mortgage costs until the buy back period is expired. That way when they defaulted, it was someone else's problem.

That's also when the payments start adjusting in most cases too. It was quite the racket until people began just taking the money and running.

Patient Renter said...

The thing I've seen a lot of stories about is where the Realtor, loan broker, or whoever, tries to convince the buyer to take cash back on loan that is greater than the sale price of the house, in order to have money for rennovations or closing costs (with a little extra), or whatever else. While the taxes are still on the assessed value, this is a bad strategy since the Realtor and/or broker's commissions are based on this inflated value, and also the buyer is paying interest on this extra amount of money throughout the life of the loan.

So, it's no good.

norcaljeff said...

AB, this is pretty common, even on new homes. I see this all the time now. Just check Craigslist. And it's also illegal. It artificially inflates the homes' price and can influence unprepared buyers. At some point these guys will get caught, and they are also helping to melt this RE market.

buying time said...

Just out of curiosity, exactly what part is illegal in CA? It seems similiar to the cash back incentives that occur in auto sales. I mean, there is no one stopping me from paying more for a house than I should (except my lender if they are smart).

norcaljeff said...

Auto makers aren't under the same reporting standards as home builders are. Plus there's a big difference in price between a car and a home, more at stake. If you bought a home for $500K and the mortgage broker was returning $100K to you, the house is only worth $400K esp if it appraised $400K. The lender is now on the hook for $500K and if you default, you obviosuly still have $100K in your pocket. So you are overstating the cost of the home and your taking money from a lender with inaccurate or misrepresented information. It's called fraud.

mr big said...

Cash back scams are designed to buy you time to make payments as real estate only goes up according to a lot of realtortards. So you have a no lose situation according to these genius folks.Have money to make payments while your house appreciates every year thus allowing you to refinance and have more money to make the payments.Only works in a market that is appreciateing.

Never get financial advice from a realtor because most of them are broke.

Caveat Emptor

buying time said...

Based on the description NCJ gave it sounds like someone is committing mortgage fraud by doing this, which means it should be illegal in all states, not just California.

Gwynster said...

Don't forget that cash back, if even remotely legal, would have have to be disclosed as income tax-wise.

norcaljeff said...

It might not be technically illegal now, but it's misleading to the lender and could easily be labeled as fraud. We went from loans requiring 20% down to protect the lender to mortgage companies giving the buyer 20-30% back as a rebate, or whatever you want to call it. Would you want to loan someone money to buy a home and find out that it's not only worth less than the loan you gave but the buyer has $100K of your money and no means to pay back the loan? So not only can the buyer walk away from the loan/house without paying, then also would walk with your $100K and you have no clue that it happened. Bigtime fraud!!!