What's the difference between a short sale and a short payoff?
Learn the difference between a short sale and a short payoff.
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Short sales and short payoffs are very similar in that both transactions involve the lender allowing your home to be sold for less than the total debt you owe. However, there are some significant distinctions between these two transactions. Short sales generally work if you are facing foreclosure or can't pay your mortgage. Short payoffs work best if you aren't having trouble with your mortgage payment. Read on to learn the difference between a short sale and a short payoff and whether either of these is a good option for you.
(To learn about options if you are facing foreclosure, see the articles in our Alternatives to Foreclosure topic page.)
When a homeowner sells his or her home for less than the total debt balance remaining on the mortgage, and the lender agrees to accept the sale proceeds to release the lien on the property, this is called a short sale. Short sales are one way that homeowners can avoid foreclosure. (Learn more about using a short sale to avoid foreclosure in Nolo's Short Sales & Deeds in Lieu of Foreclosure section.)
Example. A mortgage borrower who owes $200,000 on his house may find a buyer for the house at a sales price of $150,000. If the lender agrees to accept the $150,000 to release the mortgage, even though it is "short" of the total amount owed, this is a short sale.
Criteria for a Short Sale
Generally, to be eligible for a short sale:
- the market value of the home must have dropped significantly
- the homeowner must be in default (late on payments) or is likely to go into default soon
- the homeowner has no assets that could be used to satisfy the debt, and
- the homeowner must have experienced a financial hardship. (See our article Short Sale Hardship Letters for more information on what constitutes a hardship).
Short Sale Deficiencies
Since a short sale results in a sales price that is short of the full debt amount, the difference between the total debt and the sale price is the “deficiency.”
Example. In our example above, the lender agreed to let the homeowner sell the property for $150,000, but the total debt was $200,000. The difference of $50,000 is the deficiency.
Often with short sales, the lender will agree to waive the deficiency as part of the short sale agreement. However, if the agreement does not contain this waiver, there are many states that allow a lender to seek a personal judgment against the borrower after the short sale to recover the deficiency amount. (Learn more about deficiency judgments following a short sale.)
Lenders do not always seek a deficiency judgment after a short sale, but just to be safe, you should ask your lender to waive its right to a deficiency judgment when negotiating the approval of a short sale.
A short payoff is like a short sale in that the lender allows the property to be sold to a new owner for less than the total debt amount. Here's where a short payoff differs from a short sale: The former homeowner agrees upfront to pay back the deficiency in a promissory note with a down payment or through a payment plan.
Criteria for a Short Payoff
Generally, to be eligible for a short payoff:
- the borrower must be in good financial standing and demonstrate the ability to pay off the debt
- the lender will often require that the borrower be current on mortgage payments, and
- the borrower must have a steady income and good credit.
A short payoff can be a good option when:
- the market value of the home has dropped significantly
- the homeowner can afford to make mortgage payments
- the homeowner wants to move away from the property, and
- the homeowner does not have the ability to pay a large amount of money to cover the deficiency between the sales price and the total debt.
Pros and Cons of a Short Payoff
A short payoff allows borrowers to rid themselves of the home with little or no damage to their credit score, thus allowing them to make a subsequent home purchase immediately afterwards. The downside to short payoffs is that not all lenders are open to the idea and they can be difficult to negotiate.
Should I Do a Short Sale or a Short Payoff?
Ultimately, if you are behind in your mortgage payments (or soon will be) and are suffering from a financial hardship, then a short sale is probably the best route to pursue. However, if you are current on your mortgage payments and simply want to move away from an underwater home, then a short payoff might be the right choice for you.