Upcoming Changes in regulation Z- Flipping Property Means greater Documentation!

The practice of “flipping” real estate has been a tried and true method of make a quick profit on the quick sale of real estate for many years.  In the traditional “flip” an investor buys a somewhat devalued and distressed property, makes renovations and improvements to the property and then quickly resells the newly improved property at a handsome profit.   Generally this transaction works because the investor has a keen eye for properties that have hidden values that can be highlighted with a little bit of effort.  These transactions, generally called “flips” because the investor holds the property only briefly and flips or sells it within a short period (6-12 months), can be very profitable.  They are also high risk, because if the property does not sell in the projected time period or for the projected “flip” price, then the investor can suffer losses. 

There is of course a much darker side to “flipping”.  Unscrupulous investors working in conjunction with corrupt appraisers and sadly, in some cases crooked bankers, abused the system for their own personal gain.  BY engaging in a scheme to artificially inflate prices of worthless property, and taking profits from sham sales of real estate, the process of flipping became a major contributor to the financial woes that many in banking industry are still feeling.   It is the dark side of flipping that has led to the changes in Regulation Z appraisal requirements that will go into effect in January 2014.  

To combat this practice, when a high-priced loan is used to finance the purchase of a flipped property, a new appraisal from a different appraiser must be ordered.  In addition to being a standard appraisal, the new report must address: 

·         The difference in the original sales price and the subsequent sales price

·         Changes in market conditions

·         Property improvements the seller made

Flips and the Appraisal Requirements

In this case, the CFPB appears to be concerned about the use of a High Price Mortgage for the purchase of a flipped house.  Wow!  That seems like a mouthful!   Let’s break it down.  

A high priced mortgage is defined as:

• A first-lien mortgage (other than a jumbo loan) with an annual percentage rate (APR) that exceeds the Average Prime Offer Rate (APOR) published by the Bureau at the time the APR is set by 1.5 percentage points or more.  OR;
• It is a first-lien jumbo loan with an APR that exceeds the APOR at the time the APR is set by 2.5 percentage points or more. A loan is a jumbo loan when the principal balance exceeds the limit in effect as of the date the transaction’s rate is set for the maximum principal obligation eligible for purchase by Freddie Mac. (Comment 35(a)(1)-3)   OR;

·         It is a subordinate-lien with an APR that exceeds the APOR at the time the APR is set by 3.5 percentage points or more.

So the first question that must be determined is whether or not the loan that is being used to purchase the property is a high priced mortgage.  If not, then the rule does not apply.   In addition there are specific exemptions from the regulation that include:  

·         Qualified Mortgages, as defined in Regulation Z § 1026.43(e). For more information on Qualified Mortgages,

·         Reverse mortgages

·         Bridge loans (for 12 months or less)

·         Loans for initial construction of a dwelling (not limited to loans of 12 months or less)

·         Loans secured by new manufactured homes

·         Loans secured by boats, trailers, and mobile homes

So if the loan used to purchase the property is in any of these categories, the additional appraisal requirements do not apply.   

To complete step one; the requirements will apply when a high priced mortgage with a maturity of greater than 12 months is used to purchase a “flipped” property.

What is a Flipped Property? 

There are two categories that trigger the regulation.  

1.       A sale within 90 days of the original purchase that has an increase in value more than 10 percent;

2.       A sale within 180 days of the original purpose that has increase in value more than 20 percent. 

In other words, if it looks feels and acts like a flip, then it is!   The methods used to count the days from the purchase to the sale are rather straight forward.  We recommend that banks use the date that the deed of trust for the sale of the property is recorded.   This is the day that the property becomes the legal assets of the owner and is the most straight forward manner to determine the day that the “clock starts”. 

The regulation allows a bank can use the date that a purchase agreement is signed as the date that the property is sold and the deed of trust date as the acquisition date.   So for example, a property that is

Acquired (Deed of Trust) January 1, 2013 and then sold (purchase agreement) dated April 2, 2013[1] is a potential flip.  The next question would be what the original purchase price and the subsequent sale.   Again, the regulation is straight forward.  The amount that the purchaser pays for the house (without financing) is the purchase price.  To determine the original purchase price, you can use the deed of trust amount, or the previous sales agreement.  The point here is that the price being paid does not include financing.

So back to our example, when the house was acquired the buyer paid $400,000.  When the house was sold on April 2, 2013 if the price was more than $440,000, then the potential for a required additional appraisal exists. 

Few and Far between

One of the things that the regulation makes clear is that there should very few of these transactions as the use of a high priced mortgage to buy a flipped property is not an optimal transaction.   It should also be clear that when a bank does engage in these transactions it will serve as a red flag for regulators. 

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[1] You start counting the day after the acquisition