Shadow Lending, Shadow Flipping, Shadow Protection

Over the last few years, the media has done a great job of telling wild stories about how so-called shadow lenders are seducing Canadians with bad loans, only to foreclose and steal their houses. The term shadow evokes all the right imagery, the back alley deal, thugs with pipe wrenches, extortion, and envelopes full of money. But, taking their imaginations one step further, more recently we’ve been introduced to an entirely new kind of evil, that of shadow flipping. Here real estate agents are making double and triple commissions without lifting a finger, all at the expense of unsuspecting homeowners.

I guess we can’t get too upset with the media. After all, it’s not like they are going to let the facts get in the way of a good story. Truth is, mortgages aren’t all that exciting, so when in doubt, sensationalize!

Let’s shed some light on the reality of shadow lending and shadow flipping and expose them for what they really are.

Alternative Lending (Shadow Lending)

The term shadow lending (or shadow banking) is actually quite vague. It usually describes the practice of private lending, as well as any lending done outside the walls of a traditional bank. So, if your parents loaned you $50,000 for a down payment, they are shadow lenders.

The Bank of Canada states: “Shadow banking refers to a set of activities, outside the formal banking system, that carry out similar functions to those performed by banks.” The release goes on to say that “while the term “shadow banking” tends to suggest something secretive or illicit… on the whole, shadow banking serves a useful purpose.”

And that useful purpose is choice of mortgage products for consumers! Having more choices is one of the major benefits of working with a mortgage broker. As it becomes more difficult to secure traditional mortgage financing due to government intervention, the alternative lending space is stepping up and creating solutions for clients who would otherwise be turned away from homeownership.

Simply put, while the banks continue to narrow their qualifications, alternative lenders are filling the void and creating products priced based on risk. Sure, these products might come at a higher rate than a traditional mortgage, but ask yourself, if the bank turned you down for a mortgage for whatever reason, wouldn’t you want to at least be able to consider more options?

Assignment Clauses (Shadow Flipping)

In a piece of investigative journalism entitled “The real estate technique fuelling Vancouver’s housing market” we are introduced to the concept of shadow flipping.

The article starts with four very important words: “They had a deal.” The story goes on to how a family sold their house for a modest $5.2M, fourteen times their original purchase price, only to find it sold again three months later for $6.2M and then listed yet again at $6.58M. An assignment clause was used and the executed transaction was completely legal.

“I had no idea our house was going to be resold. We were shocked when it was flipped.” the original owner states.

This just opens the “what if?” game. Sure it seems terrible that they “lost” out on a cool million (and of course this is the main focus of the story), but what if the market took a nosedive instead? Let’s say three months down the road the property loses value and is now only worth $4.2M instead, would the seller be obligated to reimburse the buyer the difference? Of course not. After all, “they had a deal”.

Well, what is an assignment clause anyway? In a hot market, such as the one right now in Vancouver, buyers can try to include an assignment clause in a purchase contract where they can assign their rights in the contract of purchase and sell to another party. This allows the buyer to re-sell the property at a higher price before the completion date.

So, what is shadow flipping exactly? It’s when a seller agrees to sell their home at a certain price to a buyer, agrees to include an assignment clause in the contract, and the buyer uses the assignment clause to re-sell the property at a higher price before actually taking possession of the property, pocketing the difference.

Now that doesn’t sound back alley, it actually sounds quite boring.

Shadow Protection

How do you protect yourself from falling victim to shadow lending and shadow flipping (if in fact you can fall victim to them at all)? Actually quite easily. First of all, don’t buy the media hype!

After that, if you don’t understand the terms of a mortgage, ask questions. Then, if you still don’t understand, ask more questions. At that point, if you still don’t understand, seek legal counsel. And if you don’t like the terms of the mortgage presented to you, simply don’t sign.

Ultimately, no one is forcing you to sign mortgage documents.

If you are worried about being taken advantage of on a real estate contract, and the idea of someone flipping your house in the shadows upsets you, simply don’t accept any offer that includes an assignment clause. It’s just that easy!

At the end of the day, you should always seek professional advice and make informed decisions. It’s your money and your property, you have every right to spend it, or not, sell it, or not, how you see fit.

Courtesy: Dominion Lending Centres