Deed In Lieu Of Foreclosure vs. Short Sale

What are the pros and cons of accepting a deed in lieu of foreclosure in comparison to a short sale?

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Short Sale
Bill's Answer: Answered by Mark Cappel

Editor’s note: See the Bills.com resource Home Affordable Foreclosure Alternatives Program for an updated discussion of deeds in lieu of foreclosure and short sales.

Foreclosure Alternatives

Deed in lieu of foreclosure and "short sale" are alternatives to foreclosure. Because foreclosure is so devastating to a credit score, almost anything is better than foreclosure, and both of these alternatives result a somewhat lighter impact on a credit score, especially if you negotiate a resolution to the deficiency balance.

A deed in lieu of foreclosure and a short sale are very similar but there are some key differences that depend on the details of the situation. I will compare and contrast both in just a moment.

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What is a Deed in Lieu of Foreclosure?

As mentioned, a deed in lieu of foreclosure is an alternative to foreclosure. In a deed in lieu of foreclosure, the property owner gives the property to the lender voluntarily in exchange for the lender canceling the loan. The item transferred is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any foreclosure proceedings already underway. The lender may or may not agree to forgive any deficiency balance that results from the sale of the property.

Potential Tax Liabilities

An overlooked downside to a deed in lieu of foreclosure is the possible forgiveness of the deficiency balance. Under federal law, a creditor is required to file a 1099C whenever it forgives a loan balance greater than $600. This may create a tax liability for the former property owner because it is considered “income.” However, the Mortgage Forgiveness Debt Relief Act of 2007 provides tax relief for some loans forgiven in 2007 through 2013.

The key issue in a deed in lieu of foreclosure is whether the lender is willing to forgive the deficiency balance. Read the contract carefully to see how the deficiency balance issue is handled. If the document is unclear, take it to an attorney with experience in property law. An attorney’s time is not cheap, but will be a bargain compared to signing an agreement you do not understand and are surprised later to realize its implications.

Here is the typical list of deed in lieu of foreclosure or short sale requirements: a) the residence must already be on the market for a certain number of days (90 days is typical), b) there can be no liens on the property, c) the property cannot already be in foreclosure, d) the offer of a deed in lieu must be voluntary, e) for a short-sale, the seller must have a hardship, f) the house must be priced reasonably.

Is a ‘Short Sale’ a Better Option?

Underwater home

On the other hand, the property owner and lender may choose to do a short sale on the home. Through a short sale the lender agrees to accept less than the balance owed on the mortgage at sale. The deficiency balance may be forgiven.

Bills.com readers report that mortgage companies ask borrowers to accept liability for the deficiency balance. The lesson here is if you are considering either a deed in lieu of foreclosure or a short sale you must review the terms and conditions carefully and make certain you understand whether the deficiency balance is forgiven.

Unlike a deed in lieu of foreclosure, the ownership of the property is not transferred to the mortgage holder, and remains with the owner.

Lenders choose short sales because they do not want to own distressed properties. They would much rather see the owner sell the property and lose the deficiency balance than be forced to take the property through foreclosure, as foreclosure is a costly and time-consuming process.

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Whether the lender picks a deed in lieu of foreclosure or a short sale depends on how the lender balances its risks and how it wants the distressed properties to appear on their books. Local laws may have an impact on the decision, too.

One last point regarding short sales: Like deeds in lieu of foreclosure, a lender is required to file a 1099C if the debt forgiven exceeds $600. As mentioned in the deed in lieu of foreclosure section above, The Mortgage Forgiveness Debt Relief Act offers former homeowners relief for forgiven debt.

Wise Advice Each state legislature created unique foreclosure and anti-deficiency laws. Follow the links just mentioned to learn the foreclosure rules relevant to you.

What If the Lender Rejects a Short Sale Or a Deed In Lieu Of Foreclosure?

If the lender will not allow a short sale or a deed in lieu of foreclosure, foreclosure is the last option, although it presents major problems. Foreclosure auctions tend to bring significantly less money than a normal sale would bring. If the sale brings less than the amount owed on the loan, the remaining balance of the loan is called a deficiency balance.

If the home falls into foreclosure, it is possible to mitigate the negative impact of a deficiency balance by filing bankruptcy. Generally speaking, deficiency balances are treated like any other unsecured debt in bankruptcy, meaning that they can be wiped clear by Chapter 7, and repaid over time through a Chapter 13. Although bankruptcy does not sound like a positive alternative, it may be the best solution if the mortgage lender will not allow the home to be sold through a short sale or a deed in lieu of foreclosure.

Lastly, I urge you to consult with an attorney experienced in bankruptcy law to understand all of your options to resolving your mortgage debt.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

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Comments (374)


Di A.
Double Oak, TX  |  April 07, 2014
When my husband died in 2011 my children and I left the home and lived in an apartment. I was going to file bankruptcy but I would always stop. The home went vacant for 2 years. I tried to short sale it 3 times and there was always something that the mortgage company would not approve. I was allowed to move back into the home this past year and we tried different modifications, none of which they approved. Now they tell me they ran out of options and want me to either sell it short sale, deed in lieu or sell for full price. However there is a lien on the house from a credit card, and the IRS said a while ago that they would get their part for my husbands gambling debt totaling $110,000 from his winnings in 2009. I have no clue what to do other than file bankruptcy Chapter 7 and walk away.. But if I do I get no relocation money promised by the mortgage company, and we need that. Any suggestions on this mess?
Bills.com
April 08, 2014
I believe you are not taking action because you do not have enough information.

Consult with a lawyer in your state who has bankruptcy experience. He or she will review your options, including removing your liability for the mortgaged home, and will explain how the bankruptcy will impact the IRS debt.
Verna D.
Middleburg, OH  |  April 03, 2014
My husband and I are no longer able to afford a second house we own; it is currently vacant, and we owe more than it is worth. This is the home we used to live in, and it is double mortgaged; both mortgages are held by the same lender. My husband started the deed in lieu process, to avoid foreclosure proceedings. However, this was not the option I was comfortable with; therefore I did not sign any of the paperwork. They are proceeding with the DIL process. How can they do this, since my name is on both the deed and the mortgage, as a co-borrower? Don’t they need my permission? Further, I would like to explore the short sale option, because I am concerned about the implications of a DIL on our credit. I know short sale will impact our credit also, I was just hoping not as much. However, my husband said that with a short sale we would still be responsible for paying off the second mortgage, or any amount agreed upon with the lender for the short sale, that may fall short of covering BOTH mortgages. Is this accurate? We obviously cannot afford to keep the property, nor can we make a payment on a property that we no longer own. Please advise if possible. Thank you!
Bills.com
April 03, 2014
As we try to explain above, lenders offer excellent short sale deals and terrible deeds-in-lieu-of foreclosure deals. They also offer terrible short sales and excellent DILs. Without reading the proposed contract, no one can say if the deal in your spouse's hand is fair or one-sided in the lender's favor.

What to do? Find a lawyer who has experience litigating with mortgage lenders. Drag your spouse and the contract to your appointment with the lawyer and ask him or her to read the contract and explain what it means. If it's a great deal, you'll both sleep easier. If it's a terrible deal, then your lawyer can step in to negotiate something better.

Like you, I'm surprised the lender is talking to just one of you about a short sale or DIL. Perhaps the negotiator on the other side of the table assumes you will appear at the closing to sign the final title transfer.
Juan L.
Great Mills, MD  |  March 21, 2014
I already filed bankruptcy in 2009, I was told the house was foreclosure by my bankruptcy lawyer. Now the old lender cancelled the foreclosure and sold the loan to the other lender. Now we agreed to proceed to the deed in lieu. The new lender ask me to fill in "Uniform Borrower Assistance Form". I am not sure to fill in this form or not, because I filed bankruptcy before, I don't want they know my financial status. Do I need to fill in this form? Thank you for any advice.
Bills.com
March 21, 2014
You are wise to be suspicious.

Anyone who filed a successful bankruptcy petition should be very cautious about completing any form a creditor asks them to complete. It would be easy for an unscrupulous creditor to slip in fine print that reinstates the consumer's liability for a debt discharged in bankruptcy.

Bring the form you mentioned, and any other documents the lender wants you to sign, to your bankruptcy lawyer and ask him or her if you should sign and return them to the lender.
Jo B.
Elburn, IL  |  March 12, 2014
I went through a divorce in Jan 2013 after my wife had moved out in 2012. She refused to stop contributing to the mortgage and, as of November 2012 was unable to continue to make mortgage payments. I have been working with the lender yet the process has seemed to grow to a halt. The balance on the mortgage is approximately $300,000 (House is probably worth $240,000) and $47k behind in payments plus $14k in outstanding taxes. The lender has started the foreclosure process but the case keeps getting extended. Now extended til April 29. I'm trying to decide if a DIL, Short Sale, or foreclosure would be my best option and limit 1099 tax implications. Should I consider Chapter 7 or 13? My pay has been cut dramatically so a remod probably won't help. Any feedback or suggestions are welcome. Thank You!!!
Bills.com
March 12, 2014
Consult with a bankruptcy lawyer immediately. Bankruptcy may or may not be your best option, but it will eliminate your personal liability for the mortgage, any consumer debt such as credit cards and other debt. Regarding the house, he or she will review your options, including a short sale, deed-in-lieu-of foreclosure, and strategic default (foreclosure).
Cindy D.
Richmond, VA  |  February 20, 2014
After being unemployed for 8 months and exhausting all options I contacted my mortgage company October 2013 to do a short sale since my home is underwater, I was no longer able to make payments and I had it on the market for . I purchased my home for 118k in 2006 and it was appraised at 85k. My neighborhood has really suffered from many foreclosures and abandoned homes. My realtor listed my home at the appraised value per the bank for 4 months with no interest shown. we reduced the price to 70k and got two cash offers. The bank rejected them saying they needed 3k more and told me they would like to do a deed in lieu. I met with a bankruptcy lawyer to get information about a chapter 7 since I have been doing consolidation for 3 years and still have almost 20k in debt other than the house. We just received another offer that we are ready to present to the bank for the 75k. I am interested in filling the chapter 7 but am worried it might interfere with the short sale process. Should I wait to see what the bank will do before I file for chapter 7 or should I go ahead with the process while I have the opportunity?
Bills.com
February 21, 2014
Talk with your lawyer about your concerns. I don't see how filing bankruptcy now would have any negative impact on a foreclosure if you make it clear to the lender that you want to proceed with the foreclosure. But as I mentioned, involve your lawyer with any discussions you have with your creditors.
Lisa L.
Capitol Heights, MD  |  February 08, 2014
After all of the repairs, furloughs and sequestration, I decided to put my home on the market in October 2013 as a short sale. An offer was accepted in October. Papers were accepted by finance company......so we thought, after checking with the representative once a week and her saying everything was fine, well after two months we found out she'd never forwarded the information! Here we are in 2014 and waiting to close. Am I still eligible for the Mortgage Forgiveness Debt Relief Act? Oh! I owe $303,260 and my home was appraised and sold for $91,500!
Bills.com
February 10, 2014
The offer acceptance date, and not the closing date seems the be the significant date for MFDRA.

Consult with a lawyer in your state who has experience with mortgages. You may have a case against the mortgage servicer for breach of contract, or breach of fiduciary responsibility, or another cause of action.
Sam W.
Kankakee, IL  |  January 23, 2014
I recently got married and my wife has moved into my house now. While trying to get her house ready for sale we discovered the foundation needs ~ 10k worth of repair. She has a mortage and owes ~ 80k on the house. With the fall in property values over recent years the house in good condition would sell for ~ 80k. We can't afford the 10k, is short sale an option? if not are there any other options?
Bills.com
January 23, 2014
She should try to negotiate a short sale, if possible. Another option is to rent out the home, if it can be rented for an amount that covers her mortgage payment or close to it.
Cheri B.
T/o Bloomfield, NJ  |  January 14, 2014
Like many others I wish I would have come across your blog sooner that later. So here's my dilemma, my home is underwater. I purchased a townhouse in December of 2009 for 185K, it now worth around 125K, the HOA is in jeopardy of going bankrupt because only 3 of 8 units are paying their dues. The property is dire stress and 2 of the units have been abandoned by their owners. Finally the neighborhood my property is becoming crime ridden and over come with abandon properties. I am current on my mortgage but have asked my bank if I can do an arranged short sale because I just want to cut my loses sooner than later. I am working with a realtor who listed my property for 79k and we received an offer. I do not know if the bank will accept the offer because I have not submitted all of the short sale paperwork. Even though I want to unload the house by any means necessary, here are my concerns: 1. Will the bank will work with someone that is current on their mortgage. 2. How will a short sale effect my credit score. 3. Has the Loan Forgiveness act been extended into 2014. 4. Possible tax issues, if the loan forgiveness act has not been extended. I really want to unload my home and believe an arranged short sale is the only feasible route for me. Thanks
Bills.com
January 15, 2014
Cheri, I am sorry to hear the tough position that you are in. Here are my answers to your specific questions.
  1. Different banks have different standards for when they will entertain a short sale. You have nothing to lose by trying.
  2. A short sale will have a strongly negative effect on your credit score, even more so if a deficiency balance is reported.
  3. As of now, the Mortgage Forgiveness Debt Relief Act does not apply to a debt forgiven in 2014. It is possible that Congress will move to extend the protects of the MFDRA to cover 2014.(Even without the MFDRA, a person who meets the IRS standards of hardship can avoid declaring the forgiven debt as income, per the IRS Form 982.)
  4. The possible tax issues are that you would have to declare as income any amount of the debt that was forgiven. That may be, in your cost-benefit analysis, a penalty worth paying, if you are able to get your lender to agree to a short-sale, so you can relocate to a safer neighborhood and stop the stress from your current situation that must be heavy.
LaRita J.
Columbus, OH  |  January 10, 2014
I purchased a home in 2006 for my son and his wife with the agreement they would get their credit fix up so they could put house in their name. We'll stupid on my part, they got divorced 2 years later, Left me with payment. We fixed the house up some, put on market, did a lease opinion with the agreement that the guy would take over loan in 1 year, well he paid rent then after the year he could not get financed for the house, so he wanted to keep renting till he could get financed, we agreed (stupid again on my part). He quit paying rent, I had to get lawyer to evict him, which ended up in court costing me more money. Well he moved out left house in a total wreck I mean dog poop all over house they had put hole in bathroom floor to use bath room cause so much stuff was put into toilet, long story short the really tore house up. I replaced floors and remodel whole house to let my son and girl friend rent it (stupid again) Well they have not paid rent in 2 years due to drugs and jail and I can't keep paying for them, I have another rental plus my house that I live in . My question is hard will it be to do deed-in- leu? Will it hurt my other property? The house is worth more than I owe on it.
Bills.com
January 10, 2014
I don't understand why you consider a deed-in-lieu-of-foreclosure if, as you mentioned, the market value of the property is greater than the balance due on your loan. DILs and short sales are almost always used in cases where the market value of the property is less than the balance due.

Neither a deed-in-lieu-of-foreclosure or a short sale have any impact on your mortgage loan contracts you may have on other properties.

How difficult is it to complete a deed-in-lieu-of-foreclosure or a short sale? That is completely dependent on four factors:
  1. How open and receptive your mortgage servicer is to deed-in-lieu-of-foreclosures or short sales
  2. How responsive and cooperative you are with the mortgage servicer
  3. How desirable your property is to potential buyers
  4. Your local residential real estate market

Consult with a local real estate agent to learn how quickly your house will move, given its condition and likely market price. Then talk to your mortgage servicer about a deed-in-lieu-of-foreclosure or short sale if the market value is less than the balance due on your loan(s).

Jen W.
Henderson, NV  |  January 08, 2014
I really wish I had found your blog before 'signing on the dotted line'. I live in NV. We just signed our DIL forms, have moved out of the home this past weekend, and are offered some money for expenses if our home inspection goes well. When I spoke to a representative with the lender, he has always said he 'does not believe' we will be responsible for any deficiency. My husband faxed the DIL forms back before I got a chance to read them thoroughly. I am so stressed out over the possibility of paying a deficiency, as the process has been pretty 'easy' aside from losing our home. We were unemployed for a long time & simply couldnt afford our home anymore, but I feel no relief as it's unclear if we are responsible for a deficiency, and especially since the forgiveness act expired in 2013, and our process will not be considered complete until 2014.
Bills.com
January 09, 2014
The representative's statement is not exactly reassuring. Read the DIL contract and look for any discussion of the deficiency balance.

As mentioned on our Nevada Collection Laws page, Nevada allows the collection of deficiency balances. Does your servicer participate in the HAFA program? If so, it cannot collect a deficiency balance.

If you receive a 1099-C, study the IRS Cancellation of Debt Income rules carefully because you may be able to avoid some or all tax liability related to the canceled debt.
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