In the post-subprime mortgage world, it has become increasingly difficult for prospective purchasers to obtain a mortgage. Not only is credit worthiness a mandatory prerequisite but there are certain underwriting requirements that can render a property ineligible for financing. Once such underwriting hurdle is known as Seasoning and I am not talking about what you might shake onto your dinner to make it palatable. Seasoning is a real estate industry term and it basically refers to the length of time title to a specific property is held by an entity. However, these seasoning underwriting requirements are often misunderstood and inappropriately applied, thereby causing viable transactions to be turned down or to not even make it to Contract. I am going to provide a correct analysis as to what the guidelines are and how they are to be applied in the FHA arena (note many Conventional lenders have also instituted seasoning requirements but often look to FHA and mirror their guidelines).
HISTORY
To understand seasoning, it is essential to examine the events that caused FHA to create this underwriting requirement.
Real estate speculators would often locate distressed real estate, purchase the property at a substantial discount, make repairs and improvements and quickly resell the improved property at a substantial profit. There is nothing inherently wrong or illegal about this model of flipping real estate and often, it led to revitalization of run-down neighborhoods and increased neighboring property values. Some speculators would execute a Contract to purchase a distressed property and turn around and assign the right to purchase the Contract to another buyer for a price and at closing, would receive their profit without any investment at all. Again, nothing inherently wrong with the Assignment or Contract Vendee flip model either.
The problem was in a number of these transactions, the speculator would collaborate with the appraiser, the loan officer and sometimes the end buyer to artificially inflate the value of the home or to falsify the borrower's documentation so that they would qualify for a mortgage. These types of fraud transactions had a high rate of mortgage defaults because it was either never the intent of the buyer to pay the mortgage or the buyer was tricked into taking out a loan he could not afford. The Lender would foreclose and find that the value of the real property was woefully inadequate.
Therefore, to curb the fraudulent activity that often went hand in hand with flip transactions, FHA instituted a title seasoning underwriting requirement for those seeking FHA financing.
ANALYSIS
FHA's title seasoning underwriting guidelines are codified in 24 CFR 203.37a and further clarified in its Mortgagee Letter 2006-14.
FHA begins it's discussion of the Property Flipping Prohibition by defining property flipping as "
practice whereby
property is resold a short period of time after it is purchased by the Seller
for a considerable profit with an artificially inflated value, often abetted by
a lender's collusion with an appraiser". This practice is addressed by FHA with a two-prong rule: (1) only Owners of Record may sell the property and (2) prohibits resales of property 90 days or less from the last sale. (Note, there is a rule for resales that occur between 91 and 180 days as well as up to 12 months but I am not going to discuss that here).
OWNERS OF RECORD This requirement speaks directly to the assignment/contract vendee flip transaction and therefore, the Seller on the original Contract of Sale must hold title to the property. There can be no intervening deed or assignment of Contract etc. Further, FHA sets forth certain types of documentation that would be acceptable proof of Ownership but also specifically indicates that it is not an exhaustive list: (1) property sales history report; (2) copy of recorded deed from Seller or other such documentation like a property tax bill and (3) title commitment or binder demonstrating seller's ownership and the date it was acquired. Any of these items are sufficient to establish that the Seller is the Owner of Record for this test.
PROPERTY RESALES OCCURRING 90 DAYS OR LESS FOLLOWING ACQUISITION The rule is: "If the owner sells a property within 90 days of the date of acquisition, that property is not eligible security for a mortgage insured by FHA unless it falls within one of the exceptions to the time restrictions on resales set forth in Section 203.37a(c) of the Regulations". Those exceptions are as follows:
1)
Sales by HUD of Real Estate-Owned (REO) properties under 24 CFR part 291 and of
single family assets in revitalization areas pursuant to section 204 of the
National Housing Act (12 U.S.C. 1710);
(2)
Sales by another agency of the United States Government of REO single family
properties pursuant to programs operated by these agencies;
(3)
Sales of properties by nonprofit organizations approved to purchase HUD REO
single family properties at a discount with resale restrictions;
(4)
Sales of properties that were acquired by the sellers by inheritance;
(5)
Sales of properties purchased by an employer or relocation agency in connection
with the relocation of an employee;
(6)
Sales of properties by state- and federally-chartered financial institutions
and government-sponsored enterprises (GSEs);
(7)
Sales of properties by local and state government agencies; and
(8)
Only upon announcement by HUD through issuance of a notice, sales of properties
located in areas designated by the President as federal disaster areas. The
notice will specify how long the exception will be in effect.
One essential definition often glossed over is the Date of Acquisition. Most realtors, loan officers and underwriters are under the mistaken impression that the seasoning clock is reset upon every title transfer. However, FHA specifically defines the Date of Acquisition as "the date of settlement on the seller's purchase of that property" (emphasis added). Therefore, not every title transfer is to be considered in determining the Date of Acquisition for the purpose of the seasoning test.
WHAT ABOUT A TRANSFER OF REAL PROPERTY FROM A HOME OWNER TO A TRUST?
Does a transfer of title from a Homeowner to a Trustee of an inter-vivos,
revocable trust wherein the Homeowner retains 100% of the Beneficial Ownership
of that Trust constitute a Resale of Property within the meaning of 24 CFR
203.37a and HUD Mortgagee Letter 2006-14?
The transfer of title
from a homeowner to a Trustee of an inter-vivos, revocable trust wherein the
Homeowner retains 100% of the beneficial ownership of said trust does not
constitute a Resale of Property, within the meaning of 24 CFR 203.37a and HUD
Mortgagee Letter 2006-14, and therefore, as long as homeowner's initial
acquisition meets the test set forth in the Regulation and Mortgagee Letter,
the subsequent sale of the real property is eligible for FHA financing, even if
the transfer to the trust is 90 days or less from the sale contract date.
FHA will not provide
financing when the Seller's Date of Acquisition is 90 days or less from the
Purchaser's sale contract date. FHA
defines the Date of Acquisition as "the date of settlement on the seller's
purchase of that property" (pg 2 Mortgagee Letter). The transfer of title
from the Homeowner to a Trustee is not a purchase but a mere change of
identity. The trust and the homeowner
share a commonality of ownership and control over the real property. Such
transaction is without consideration and exempt from the payment of state and
local transfer taxes based upon the "mere change of identity"
exception. Therefore, the Date of
Acquisition is the date the Seller originally purchased the real property for
consideration.
It is unnecessary and
improper to look to the codified exceptions to the 90 days or less rule,
outlined in 24 CFR 203.37a(c), if the date of the title transfer to the trustee
is 90 days or less than the purchaser's sale contract date because such date is not
the Date of Acquisition under the Rule and Mortgagee Letter. If the contemplated transaction has a Date of
Acquisition that is 90 days or less than the sale contract date, the Rule
provides certain exceptions to the time restrictions on resales. However, as the date of title transfer to the
trust does not constitute the Date of Acquisition, it is unnecessary to look to
the exceptions provided in 24 CFR 203.37a(c), except if the date the Homeowner purchased the property, for
consideration, is 90 days or less from the sale contract date.
CONCLUSION
The real estate flip is not illegal in and of itself. The often accompanying loan and appraisal fraud is what makes this perfectly legitimate transaction fraudulent and the basis for FHA and other lenders to institute title seasoning underwriting requirements. If done correctly, the flip often revitalizes neighborhoods and increases home values in the surrounding areas.
I hope that this clarifies exactly what is meant by Title Seasoning and how this underwriting requirement should be correctly applied to a contemplated real property transaction. Remember, not every title transfer triggers that seasoning clock but be mindful of those that do!
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