If you are facing foreclosure and your lender has denied your request for a repayment plan, forbearance, or loan modification (or if you are not interested in any of those options), there are other things you can do to avoid foreclosure (called loss mitigation). Two of these options include a short sale or a deed in lieu of foreclosure. Because short sales and deeds in lieu are similar transactions, many people get them confused. But there are differences.
Here you can learn about short sales and deeds in lieu, the differences between the two, and how they could help you prevent a foreclosure.
A short sale occurs when a homeowner sells his or her home to a third party for less than the total debt remaining on the mortgage. With a short sale, the lender agrees to accept the proceeds from the sale in exchange for releasing the lien on the property. (Learn more about short sales to avoid foreclosure.)
The lender’s loss mitigation department must approve the short sale before the transaction can be completed. To be approved for a short sale, the seller must submit a loss mitigation application, which includes:
The purchase offer. A short sale application will also most likely require that you include an offer from a potential purchaser. Lenders generally insist that there be an offer on the table before they will consider a short sale. An exception to this is with the government’s Home Affordable Foreclosure Alternatives Program (HAFA) program, where the lender approves the short sale terms prior to listing the home and then accepts the short payoff in full satisfaction of the mortgage. Learn more about HAFA short sales.
Most homeowners who complete a short sale will face a deficiency judgment. There are some exceptions: the lender cannot get a deficiency with a HAFA short sale and a few states disallow deficiencies after short sales.
What is a deficiency? Since the sale price is “short” of the full debt amount in a short sale, the difference between the total debt and the sale price is the “deficiency.”
Example. Say you are approved by your lender to sell your property for $200,000, but you owe them $250,000. The deficiency is $50,000. In many states, the lender can seek a personal judgment against you after the short sale to recover the deficiency amount.
Anti-deficiency laws. While many states have enacted legislation that prohibits a deficiency judgment following a foreclosure, most states do not have a corresponding law that would prevent a deficiency judgment following a short sale. California is an example of a state that does have specific legislation prohibiting a deficiency judgment following a short sale, however most states have no such prohibition. (To find out the law in your state, visit our Deficiency After Foreclosure area. You can find articles on deficiencies after foreclosure, short sale, and deeds in lieu in all 50 states.)
How to avoid a deficiency with a short sale. To ensure that the lender cannot obtain a deficiency judgment against you following a short sale, the short sale agreement must expressly state that the transaction is in full satisfaction of the debt and that the lender waives its right to the deficiency.
Learn more about how to avoid a deficiency judgment following a short sale.
If you are unable to sell your home through a short sale, another option to avoid foreclosure is a deed in lieu of foreclosure.
A deed in lieu of foreclosure is a transaction where the homeowner voluntarily transfers title to the property to the lender in exchange for a release from the mortgage obligation. (Learn more about deeds in lieu of foreclosure.)
Just like with a short sale, the first step in obtaining a deed in lieu of foreclosure is for the borrower to request a loss mitigation package from the lender. The application will need to be filled out and submitted along with documentation about your income and expenses including:
Listing the property for sale. The lender will also most likely require that you try to sell your home for at least 90 days before it will consider accepting a deed in lieu, and will require a copy of the listing agreement as proof that this has been done.
If approved for a deed in lieu of foreclosure, the lender will send you documents to sign. You will receive:
The estoppel affidavit sets out the terms of the agreement and will include a provision that you are acting freely and voluntarily. It may also include provisions addressing whether the transaction is in full satisfaction of the debt or whether the lender has the right to seek a deficiency judgment.
With a deed in lieu of foreclosure, the deficiency amount is the difference between the fair market value of the property and the total debt. In most cases, completing a deed in lieu will release the borrowers from all obligations and liability under the mortgage, but this is not always the case.
Anti-deficiency laws. Most states do not have a law that prevents a lender from obtaining a deficiency judgment following a deed in lieu of foreclosure. This means that a lender may try to hold you liable for a deficiency following the transaction. Washington is one state that does have explicit case law that states a lender may not obtain a deficiency judgment after a deed in lieu of foreclosure (Thompson v. Smith, 58 Wn. App. 361 ).
There will be no deficiency if the deed in lieu of foreclosure is done through HAFA. With HAFA deeds in lieu of foreclosure, the transaction is considered full satisfaction of the debt. Learn more about HAFA deeds in lieu of foreclosure.
How to avoid a deficiency with a deed in lieu of foreclosure. To avoid a deficiency judgment with a deed in lieu of foreclosure, the agreement must expressly state that the transaction is in full satisfaction of the debt. If the deed in lieu of foreclosure agreement does not contain this provision, the lender may file a lawsuit to obtain a deficiency judgment.
You can learn more about short sales and deeds in lieu of foreclosure in Nolo's Short Sales & Deeds in Lieu of Foreclosure section.