Whenever I talk or write about real estate and mortgage fraud, one of the topics that people seem to have the most trouble understanding is why cash back at closing deals are often wrong or flat out illegal.

In real estate, cash back at closing occurs when a buyer intentionally pays more for a property than what the seller expects to receive with the understanding that the excess funds will be refunded to the buyer at closing. It is essentially a way to fool a lender into approving a mortgage loan for more money than the property is worth.

On the surface, cash back at closing seems, at their worst, to be victimless crimes. At their best, they seem to benefit everyone involved. The sellers get what they want for their homes. The buyers get cash back at closing. The real estate agent earns a bigger commission. The lender gets to collect more interest on a bigger loan. And the appraiser generates more business and perhaps even a "bonus" for supplying an inflated appraisal.

Unfortunately, the victimless crime claim is a myth. What actually happens is that the lender is duped into approving a loan that it may otherwise have rejected had it been presented with accurate information. Buyers are saddled with loans that have monthly payments they may not be able to afford. Housing values become inflated. Property taxes rise. The housing bubble eventually bursts. And everyone suffers.

Many people who read my articles on the evils of cash back at closing write to me describing scenarios in which they feel cash back at closing would be justified. The most recent scenario was the following:

1. The seller is facing foreclosure and is highly motivated to sell.

2. The buyer has good credit, a suitable down payment, and a desire to make a deal.

3. The home is listed and has been appraised at $480,000.

4. The seller is willing to discount the home by $80,000. (The seller loses some equity in the home but dodges the foreclosure bullet and saves part of his credit in the process.)

5. Instead of purchasing the home for $80,000 less, the buyer agrees to pay the full price of $480,000 with the agreement that the seller will pay back an "incentive" at closing of $80,000. This would give the buyer the necessary funds to fix up the property.

6. The buyer delivers a real cash down payment that is proven to be in his bank account prior to the purchase, as per the bank's requirements.

7. The bank has approved the loan based on its own appraiser's evaluation and receives a suitable down payment of 5 to 20 percent depending on the loan requirements.

The question is: How can this possibly be inappropriate, since the bank hasn't really taken on any additional risk? This is a pretty good question, but the fact is that this still constitutes mortgage fraud.

Why? Well, the true market value of the home is the lesser of the appraised price or the actual price paid for the property. In this case, the true market value of the property is not $480,000. It is actually the price the seller is willing to accept -- $400,000. Presenting to the bank that the actual sales price is $480,000 is misleading.

As real estate brokers, we are often told that "As long as the information is presented on the HUD statement, the transaction is legal." What happens in almost all situations such as the scenario presented here, is that the professionals involved create two HUD statements -- one for the closing and another that is sent to the bank or they camouflage the $80,000 junior lien or a recently created obligation of the seller. In other words, everything is not being fully disclosed.

This is obviously a deceptive practice designed to mislead the bank into approving a loan it would otherwise reject. If you have to create two HUD statements -- one for the closing table and one for the lender or one that is camouflaged in some way to justify a transaction, then what you are doing is illegal. If the HUD was a person then it could be accused or indicted as a co-conspirator.

I know of only a handful of situations in which receiving cash back at closing is legal:

1. You refinance your mortgage to cash out some or all of the equity in your home.

2. Your agent agrees to refund a portion of his or her commission at closing.

3. The buyer makes a deposit into the escrow fund, obtains a 100 percent loan, and then receives a credit back. This isn’t considered cash back at closing, because it is the buyer's own money.

Other than scenarios such as these, cash back at closing deals are unethical and illegal. There are good reasons behind the rules and regulations that govern real estate transactions. When we begin to bend those rules under the false assumption that nobody is getting hurt, we compromise the very integrity of the real estate industry and damage the industry on which we make a living.

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