Short sales are transactions in which proceeds from the sale amount to less than the balance owed on the property. Though short sales can be a fiscally smart and a radically less agonizing option when facing foreclosure, it is not possible to have a related party purchase your property in a short sale. These transactions are typically used as an alternative to foreclosure in order to alleviate expenses for both homeowners and lenders and more often than not occur after a borrower’s failed attempt to modify their mortgage loan in order to remain in their home.
In short sales, banks require that transactions be executed at “arm’s length;” that is, all parties to the transaction must be independent and on equal footing. For example, a transaction in which your friend or relative offers to purchase your underwater property at fair market value in order to work out a rental or re-sale agreement that would allow you to continue to live in your home would not be considered an arm’s-length deal and result in the lender invalidating the transaction. In a scenario like the latter, the seller stands to benefit greatly, and as the law dictates, sellers cannot profit from a short sale.
Arm’s-length policies have become more stringent since the housing market crash due in part to real estate scam artists taking advantage of the housing market’s economic downturn. Unfortunately for honest, hardworking homeowners suffering financial losses through no fault of their own, these policies can seem heavy-handed and unfair. However, because short sales are high-risk transactions by nature, lenders have implemented these strict policies to protect their assets from mortgage fraud.