Difference Between Short Sale, Deed in Lieu of Foreclosure?

In recent years, rapidly declining home prices combined with sharply elevated unemployment and stagnant wages have put many homeowners across the country in a quandary: They are unable to afford their mortgage payments but cannot sell because they owe far more than their homes’ current values.

When a homeowner stops paying his mortgage, it usually leads to foreclosure by the lender. In a foreclosure, the lender forcibly retains ownership of the property, and the delinquent party is evicted from the home. For a homeowner struggling with mortgage payments, succumbing to a foreclosure should be a last resort. A foreclosure is costly, ruins a person’s credit for many years, and carries an awful stigma.

Two alternatives that can help struggling homeowners stave off foreclosure are a short sale and a deed in lieu of foreclosure. Both options are similar in scope and procedure, and either one is preferable to a foreclosure. However, there are a few important differences between the two that are important to understand.

How Does a Short Sale Work?

In a short sale, the lender, or lienholder, permits the borrower to sell the home at an agreed-upon price that is below the outstanding mortgage balance. Once the sale closes, the lienholder releases the borrower from his obligation.

Typically, there is a negotiation between the homeowner and the lender to settle on a minimum price at which a short sale will be permitted. The lender, obviously, wants to recoup as much of its money as possible on the sale. But the lender also does not want the house to sit on the market for months on end with no offers while it continues to receive no mortgage payments, so it is generally willing to accept a low sale price as long as it is near the home’s current market value.

Before short-selling a home, the borrower must receive approval from the lender. To do this, he must prove his inability to pay the mortgage. This means he must produce several documents, including detailed financial statements, proof of income, tax returns, bank statements, and a personally-written letter detailing his financial hardship.

In addition, some lenders require that an offer to buy the home already be on the table before it will approve a short sale. Once the sale is complete, the lender retains ownership and the borrower is released from the mortgage.

What is a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure is similar to a short sale in that the borrower voluntarily gives up ownership of the home and the lender releases him from his mortgage.

What makes a deed in lieu of foreclosure different is that no sale of the home is made. Instead, the homeowner voluntarily deeds the home back to the lender, who then can sell the home, receive the proceeds, and try to recoup as much of the outstanding mortgage balance as possible.

As in a short sale, the borrower must prove a financial hardship and inability to make his mortgage payments for the lender to approve a deed in lieu of foreclosure. Moreover, most lenders require that the borrower have had the home on the market with no offers for a given period of time, such as 90 days.

To prove financial hardship, a borrower seeking a deed in lieu of foreclosure will be asked to produce the same five documents as in a short sale. When he is approved, he must sign a deed to transfer ownership and an estoppel affidavit. These documents state the terms of the deal and that the borrower is voluntarily giving up the home to the lender. At that point, he is released from his mortgage and ownership of the home reverts to the lender.

What is a Deficiency Judgment?

In either a short sale or a deed in lieu of foreclosure, there is a difference between the amount the borrower owes and the amount the lender actually receives in the transaction. In a short sale, it’s the difference between the mortgage balance and the sale price. In a deed in lieu of foreclosure, it’s the difference between the mortgage balance and the market value of the home.

Most states allow lenders to seek judgments against borrowers for that difference, known as a deficiency balance. Unless a borrower lives in a state where deficiency judgments are prohibited or it is explicitly stated in the short sale or deed in lieu of foreclosure agreement that one will not be sought, a borrower should understand that he stands a chance of being pursued for his deficiency balance.

Short sales and deeds in lieu of foreclosure are favorable alternatives to foreclosure. Struggling borrowers should educate themselves on the differences between the two, as well as the steps to take to avoid a deficiency judgment.  If you are facing any type of judgement or foreclosure then it may be in your best interest to contact us for help today.

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