Homeowners who find themselves unable to make their mortgage payments will often be in a difficult situation of facing a possible foreclosure. This problem is particularly exacerbated when the homeowner is underwater – owing more debt on the mortgage than the house is worth. Foreclosures are highly undesirable and come with many negative consequences. Fortunately, there are alternatives available and in many cases, either a short sale or a deed in lieu of foreclosure may be possible. While both options often seem similar, there are some key difference that are important to know.
A short sale is a transaction in which the lender agrees to allow the sale of a house at a reasonable price that is less than the outstanding mortgage. In exchange, the lender will release the lien on the property.
A short sale requires advance approval by the lender. Typically, the borrower must first prove his inability to make mortgage payments by submitting:
- a detailed financial statement,
- proof of income, if applicable,
- recent tax returns,
- recent bank statements, and
- a hardship letter.
Additionally, the lender will generally require that the homeowner already has an offer to buy the house before a short sale is considered. However, if these items are made available and the short sale is approved, the borrower will sell the house for less than the outstanding mortgage value and will be released from his mortgage and lien by the lender.
Deed in Lieu of Foreclosure
A deed in lieu of foreclosure is, in many ways, similar to a short sale. In both cases, the end result is that that the lender will release the borrower from the mortgage. However, there are a few differences in the process.
Typically, a borrower can request a deed in lieu of foreclosure if he faces financial hardship and he has not been able to sell the house via a regular sale or a short sale. The borrower will then have to provide the same five items as those listed above for a short sale. Additionally, lenders often require that the house will have been on the market for sale for at least ninety days.
If all these criteria have been met and the lender approves the deed in lieu of foreclose, the borrower will receive two documents to sign: a deed to transfer ownership to the lender and an estoppel affidavit. This affidavit sets the terms of the agreement and states that the borrower is acting voluntarily in transferring the deed. Once the two documents are completed, the transaction will be approved and as in a short sale, the lender will release the borrower from the mortgage.
Special Note about Deficiency Judgments
Both transactions sometimes leave open the possibility for a lender to seek a deficiency judgment against the borrower, because the lender accepts a settlement in which he receives less than the outstanding debt. In the case of a short sale, this is the difference between the outstanding mortgage value and the sale price of the house. In the case of a deed in lieu of foreclosure, this is the difference between the outstanding mortgage value and the fair market value of the house.
Some states have specific laws that prohibit lenders from seeking such deficiency judgments, but this is the exception rather than the rule. In many other cases, deficiency judgments are a real possibility. For this reason, it is highly important to ensure that either the short sale or the deed in lieu of foreclosure document specifically states that the agreement fully satisfies the lender and contains other language to close the possibility of a deficiency judgment.
Although both options are similar, there are some differences that are important to know. It is also important that the required processes are properly followed and that all documents are checked for legal sufficiency and to insure that lenders cannot seek deficiency judgments. However, if the proper steps are taken, then regardless of which option is chosen, they both provide homeowners with an attractive alternative to facing a foreclosure.
How we can help you
Understanding the difference between short sale and deed in lieu of foreclosure can make a world of difference. Use our contact form or call Tucker, Nong and Associates to hear how our experienced legal team can guide you to the best decision.