If your loan holder, called the "bank" in this article, has denied your request for a repayment plan, forbearance, or loan modification (or if you're not interested in any of those options), two other ways to avoid a foreclosure are:
One benefit to these alternatives is that you won't have a foreclosure on your credit history. But your credit scores will still take a major hit. A short sale or deed in lieu is almost as harmful as a foreclosure when it comes to credit scores. For some people, though, not having the stigma of a foreclosure on their record is worth the effort of working out one of these alternatives. Another upside is that some banks offer relocation assistance, often a thousand dollars or more, to help homeowners find new housing after a short sale or deed in lieu.
Read on to learn how short sales and deeds in lieu work, the differences between the two, and the pros and cons of arranging one of these options to prevent a foreclosure.
A "short sale" occurs when a homeowner sells the property to a third party for less than the total mortgage debt. With a short sale, the bank agrees to accept the sale proceeds in exchange for releasing the lien on the property.
The bank's loss mitigation department must approve a short sale before the transaction can be completed. To get approval for a short sale, the seller (the homeowner) must contact the loan servicer to ask for a loss mitigation application. The homeowner then must send the servicer a complete application, which usually includes:
A short sale application will also most likely require that you include an offer from a potential purchaser. Banks often insist that there be an offer on the table before they'll consider a short sale, but not always. And, if the property has one mortgage loan on it, like a first and second mortgage, both loan holders must consent to the short sale. The first mortgage holder will usually offer a certain amount from the short sale proceeds to the second mortgage holder to release their lien. But the second mortgage holder can refuse to accept the amount and kill the deal. If you have any other liens on your home, like a judgment lien, that lienholder will also have to agree to the deal.
While many states have enacted legislation prohibiting a deficiency judgment following a foreclosure, most states don't have a corresponding law preventing a deficiency judgment following a short sale. California, and a few other states, do have a law that prohibits a deficiency judgment following a short sale. But most states don't have this kind of prohibition. So, many homeowners who complete a short sale will face a deficiency judgment.
To ensure that the bank can't get a deficiency judgment against you following a short sale, you need to make sure that the short sale agreement expressly says that the transaction is in full satisfaction of the debt and that the bank waives its right to the deficiency. Avoiding a deficiency judgment is the main benefit of a short sale. If you can't get the bank to agree to waive the deficiency entirely, try to negotiate a reduced deficiency amount. If a foreclosure is imminent and you don't have much time to sell, you might consider filing for Chapter 13 bankruptcy with a plan to sell your property.
If the bank forgives some or all of the deficiency and issues you an IRS Form 1099-C, you might have to include the forgiven debt as income on your tax return and pay taxes on it.
Another way to avoid a foreclosure is by completing a deed in lieu. A "deed in lieu" is a transaction in which the homeowner voluntarily transfers title to the property to the bank in exchange for releasing the mortgage (or deed of trust) securing the loan. Unlike with a short sale, one benefit to a deed in lieu is that you don't have to take responsibility for selling your house.
Generally, a bank will approve a deed in lieu only if the property has no liens other than the mortgage.
Because the difference in how a foreclosure or deed in lieu affects your credit is minimal, it might not be worth completing a deed in lieu unless the bank agrees to:
Banks sometimes agree to these terms to avoid the expense and hassle of foreclosing.
If you have a lot of equity in the property, though, a deed in lieu usually isn't a good way to go. In most cases, you'll be better off by selling the home and paying off the debt.
Like with a short sale, the first step in getting approval for a deed in lieu is to contact the servicer and request a loss mitigation application. As with a short sale request, the application will need to be filled out and submitted along with documentation about income and expenses.
The bank might require that you try to sell your home before considering a deed in lieu and require a copy of the listing agreement.
If you're approved for a deed in lieu, the bank 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're acting freely and voluntarily. It might also include clauses addressing whether the transaction completely satisfies the debt or whether the bank has the right to seek a deficiency judgment against you.
With a deed in lieu, the deficiency is the difference between the total mortgage debt and the property's fair market value. In most cases, completing a deed in lieu will release the borrowers from all obligations and liability—but not always.
Most states don't have a law that prevents a bank from obtaining a deficiency judgment following a deed in lieu. Washington, however, has at least one case in which a court prohibited a deficiency judgment after this kind of transaction. (See Thompson v. Smith, 58 Wash. App. 361 (1990)). Also, Nevada law doesn't allow deficiency judgments after deeds in lieu of foreclosure under certain circumstances. So, if state law permits it, the bank might try to hold you liable for a deficiency following a deed in lieu. If the bank wants to preserve its right to seek a deficiency judgment, it generally must clearly state in the transaction documents that a balance remains after the deed in lieu. It must also include the amount of the deficiency.
To avoid a deficiency judgment with a deed in lieu, the agreement must expressly state that the transaction is in full satisfaction of the debt. If the deed in lieu agreement doesn't have this provision, the bank might file a lawsuit to get a deficiency judgment against you. Again, if you can't get the bank to agree to waive the deficiency entirely, you might try negotiating a reduced deficiency amount. And you might have a tax liability for any forgiven debt.
If your main goal is to avoid a deficiency judgment, you might consider filing for bankruptcy instead. With a Chapter 7 bankruptcy, filers aren't required to pay back any deficiency, though not everyone qualifies for this kind of bankruptcy. In a Chapter 13 bankruptcy case, debtors pay their discretionary income to their creditors over the course of a three- to five-year repayment plan. The bank will likely receive little or nothing for a deficiency judgment through a Chapter 13 repayment plan. When you complete all of your plan payments, the deficiency judgment will be discharged along with your other dischargeable debts.
Be aware, though, that a foreclosure, short sale, and deed in lieu of foreclosure are all pretty similar when it comes to impacting your credit. They're all bad. But bankruptcy is worse.
If you need help figuring out which option is best for your situation, or you want to learn about potential defenses to foreclosure that might apply to your circumstances, consider talking to a foreclosure attorney. To get help applying for a short sale or deed in lieu, talk to a HUD-approved housing counselor. To get more information about filing for bankruptcy, talk to a bankruptcy lawyer.