In the article When Sellers Must Be Flexible [NYT]  a buyer illustrates how they were able to purchase a property with a limited amount for a down payment. The seller agreed to pay for closing costs in exchange for the higher purchase price. At the end of the day the seller would net out the same amount and the buyer gets the house.
Everyone wins, right?
- I’d be willing to bet that the property was overappraised and the seller concession was not considered or known about.
- The lender did not realize that their asset was inadequate for the collateral.
- This sale closes and becomes a data point for other valuations.
Whether or not these assumptions are true, this type of creative transaction, no matter what flavor, happens all the time. In other words, everyone but the lender wins. Thats because the lender was exposed to risk that is not built into their cost of doing business. A portion of risk in the transaction was shifted from the buyer to the lender.
What if you multiplied this type of activity by a million? Is the risk significant then?
If you read the entire article, you can see how matter of fact this transaction was handled. The mortgage broker says:
The appraisal has to come in at the increased purchased price, and obviously the credit and everything else needs to be excellent.
If the property was not selling and this was the best the seller could do (why else would they accept this type of arrangement?) then it would seem unlikely that an accurate or well-done appraisal would come in at the sales price. Its certainly possible but does not appear to be a reasonable assumption given the circumstances.
As the housing market cools, more of these creative financing techniques will be necessary to keep the real estate economy going, and its going to require a lot of backbone by the appraisal industry to stay honest. Hopefully lenders will become aware of their vulnerability at some point.
Here’s another creative financing technique discussed in For Home Loan Broker, Troubles Come With Creative Refinancing [LA Times] 
This is compelling evidence of the current flawed structure of the mortgage home loan business.