What's the difference between a short sale and a short payoff?

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. But 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 other options if you are facing foreclosure, see Avoiding Foreclosure: Basic Workout Options.)

Short Sales

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.)

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. (Read about short sale hardship letters and affidavits for more information on what constitutes a hardship).

Short Sale Deficiencies

Because 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.

Sometimes the former homeowner agrees upfront to pay back some of the deficiency in a promissory note with a down payment or through a payment plan. Other times, the lender will agree to waive the deficiency as part of the short sale agreement. (If the lender forgives some or all of the deficiency, you might be liable to pay taxes on the cancelled amount.) However, if the agreement does not contain a 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.)

Short Payoffs

A short payoff is when a lender agrees to accept less than the full balance of the mortgage loan as payment in full for the debt.

Criteria for a Short Payoff

Generally, to be eligible for a short payoff:

• the borrower must demonstrate the ability to pay off the debt
• the lender will sometimes 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 damage to their credit score. The downside to short payoffs is that not all lenders are open to the idea and they can be difficult to negotiate. And, again, you might be liable to pay taxes on any forgiven amount.

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, have financial resources, and simply want to move away from an underwater home, then a short payoff might be the right choice for you.