What Is 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 they're not the same. 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 transactions is a good option for you.

How Do Short Sales Work?

When a home sale results in 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, the transaction is called a "short sale." Short sales are one way that homeowners can avoid foreclosure.

Example. A mortgage borrower who owes $300,000 on the house finds a buyer for the property at a sales price of $250,000. The lender agrees to accept $250,000 to release the mortgage, even though this amount 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 little or no assets that could be used to satisfy the debt, and
• the homeowner must have experienced a financial hardship.

Short Sale Deficiencies

Because a short sale results in a sales price that's 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 $250,000, but the total debt was $300,000. 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 canceled amount.) However, if the agreement doesn't contain a waiver, some states allow a lender to seek a personal judgment against the borrower after the short sale to recover the deficiency amount.

How Do Short Payoffs Work?

A "short payoff" is when a lender agrees to accept less than the mortgage's full balance 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 doesn't 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're behind in your mortgage payments (or soon will be) and are suffering from a financial hardship, then a short sale might be appropriate. But if you're 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. To learn more about whether one of these options is appropriate in your circumstances, consider talking to a foreclosure lawyer.