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.
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 2012.
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?
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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.
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.
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
Spokane, MO | June 24, 2011
June 26, 2011
My advice? Clean up the property and be ruthless in disposing of old and out-of-style furniture, draperies, and carpeting. Scrape together some funds and hire a painter (there will be a dozen vying for your business) to paint the inside and outside in a neutral set of light, inoffensive colors. Hire a landscaper to trim any trees and bushes, and plant a few nice flowers. Hire a real estate agent and price the house competitively. An appealing property priced right will move quickly.
Sterling Heights, MI | July 06, 2011
July 06, 2011
Denver, CO | July 14, 2011
July 15, 2011
- I do not see how a foreclosure on one of your homes will impact the sale of another. Let us say for the sake of argument that the same mortgage servicer handled both loans. The servicer may work on behalf of two different investors, so it has a fiduciary duty to the investors and not its own interests. However, if the same investor and same servicer are involved in both properties, you may see the servicer connect the dots and try to discuss both transactions in the same conversation. If that occurs, then I urge you to consult with a lawyer in Michigan or Colorado to assist you in the negotiations.
- Consult with a bankruptcy lawyer in Colorado to learn if you pass the Chapter 7 means test.
Please return here to tell us how the foreclosure and the home sale occurred, and how the servicer(s) acted.
Chicago, IL | July 20, 2011
July 21, 2011
Brown Deer, WI | June 23, 2011
June 23, 2011
- I think you are asking why some people procrastinate. Answer that, and you will help solve many significant world problems.
- If the landlord can convince the mortgage servicer that it is in their best interest to delay the foreclosure sale, then the mortgage servicer will ask the court to postpone the sale. Whether this occurs is not for me to say. If the landlord has credibility in the eyes of the servicer, then sure, a postponement may be granted.
- You have rights as a tenant. See the Bills.com resource Protecting Tenants at Foreclosure Act of 2009 to learn more. In my opinion, a property with existing tenants who pay their rent on time is much more valuable than a vacant rental property or a rental with deadbeat tenants.
If you have a lease contract, and are not month-to-month, and are paying on time, your contract is valid. If you are a month-to-month tenant, then you would be wise to start looking elsewhere for different housing.
Chandler, AZ | June 13, 2011
June 14, 2011
Phoenix, AZ | August 07, 2011
Haltom City, TX | June 08, 2011
June 08, 2011
Consult with your probate lawyer to learn what, if any, recourse the lender has if you stop paying the mortgage. If, as you suggest, the property is worth the same or less than the balance of the loan, I do not see a financial reason for you to continue to pay the mortgage.
Elk Grove, CA | June 07, 2011
June 07, 2011
Albuquerque, NM | June 06, 2011
June 06, 2011
Either a deed-in-lieu-of-foreclosure or a short sale are voluntary agreements on the part of the mortgage servicer (which is representing the mortgage's investor) and the borrower. There are no universal qualification criteria for either — each mortgage servicer negotiates deals separately.
Deeds-in-lieu are not as common as short sales, and the impact deeds-in-lieu have on a credit score are not discussed by Fair Isaac & Co., creator of the FICO score. My guess — note that word choice — is that if the homeowner remains current on their payments, a deed-in-lieu will cause a minimal impact on a credit score. I welcome comments from readers with deed-in-lieu experience to share below what impact it had on their credit score.
Meridian, ID | May 30, 2011
May 31, 2011
Your options are further constrained because the home is not your primary residence. Was it your primary residence for two of the past five years? If so, you may be able to avoid having any deficiency balance considered as income, though you should speak to a tax professional about this.
If you can avoid the deficiency balance being considered as income and costing you in income tax, then you may want to consider a strategic default. If that is something you want to consider, review these two articles:
Also, I recommend that you speak with an attorney who has experience working on this kind of case, if you are going to pursue a strategic default.
Panama City, FL | May 23, 2011
May 24, 2011
If you want to stay in the property, but at a lower monthly cost, consider an FHA Short Refinance.
Ostrander, OH | May 19, 2011
May 19, 2011
- Mortgage: You mentioned the balance of your loan exceeds the market value of the property. Consider an FHA Short Refinance to knock-down the mortgage principal and cut your interest rate. A successful short refinance will make your mortgage payments less.
- Credit Card Debt: You mentioned hardship programs. Consider Chapter 7 or 13 bankruptcy, or a debt settlement plan, which would be more aggressive than a credit card issuer's hardship program. See also the Bills.com Debt Coach online application that will help you find the right debt resolution program for you.
- Household Budget: Revisit your household budget and look hard at all of the expenses you might be taking for granted:
- Cable TV: If you have premium channels, get rid of them. Or, get rid of your cable TV altogether and watch what you want when you want with Hulu and Netflix.
- Land Line: How often do you use it?
- Cell Phone Plan: When your current plan expires, cancel it and use a pay-as-you-go plan.
- Car Insurance: Raise your deductible. Cancel collision if the car is worth less than $2,000. Also, shop your insurance every year or two.
- Common Sense: Make a household budget and stick to it. Make saving a priority, and so on.
You asked about mortgage servicers requiring homeowners to become delinquent before discussing any hardship plan. Unfortunately, some have that requirement, which wreaks havoc on a credit report and score. Do look into an FHA Short Refinance, but also continue to talk with your servicer, and explain you are contemplating a short refinance. That disclosure may open up a door for you to a modification.
Lakeland, FL | May 13, 2011
May 13, 2011
Regarding your central question, you never want to surprise a bankruptcy trustee, or do anything with your personal finances without the trustee's approval. Apply for a short sale or deed in lieu after you receive the trustee's explicit approval only. Your failure to do so could scuttle your bankruptcy filing.
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