Should I do a deed in lieu of foreclosure?
Hello there Bill, GREAT post and answers to all the previous questions. Here's mine: My boyfriend and I live in Las Vegas -- foreclosure capital of the country as you mentioned in a previous question. We bought our condo in 2006 for $150,000. It's now worth about $45,000 and our loan is at $112,000. We are current on our payments, but we have an arm that will come due in 2011. Our rate is 5.5% while current rates are around 3.5%. My boyfriend's income has all but disappeared and almost all our bills are on my shoulders. We would like to get out of this condo and buy something for much less at a much lower rate. We are thinking deed in lieu of foreclosure might be a good option for us but we aren't really sure. What's your advice?
Generally speaking, I suggest people try to do a short sale rather than a deed in lieu of foreclosure. The reason I typically prefer a short sale has to do with a persons credit after doing a short sale in comparison to a deed in lieu of foreclosure. In regards to the credit score, the negative credit impact of a short sale is generally significantly less than that of a foreclosure. A short sale will not appear as a foreclosure on a credit report, and therefore only the previous delinquency on the mortgage will appear. Also, I believe that most mortgage lenders report a mortgage that is paid through a short sale as being in a redemption status. While the delinquency and change of status on the mortgage loan will certainly lower a persons credit rating, from my experience, the negative impact is usually much less than the negative credit implications of an actual foreclosure. If a person must choose between a short sale and allowing their home to go into foreclosure, from a credit perspective, a short sale is probably the wiser choice. I encourage anyone going through this situation to speak with an experienced real estate attorney to discuss the details of their situation to help them determine the best course of action in their circumstances.
If a person is successful in selling their home in a short sale, they may still be liable for the difference between the amount they owed on the mortgage and the amount of the sale, which is referred to as a deficiency balance. If they owe a deficiency balance, the lender may be able to pursue them for collection of the debt, depending on their state's laws regarding deficiency balances on homes. Some states, such as California, do not allow for the collection of deficiency balances on purchase money loans. However, if a person lives in a state which does allow for the collection of deficiency balances, the creditor may be able to sue the person and obtain a judgment for the amount owed. A judgment can appear on a credit report and negatively impact the credit rating. Many creditors do not pursue former homeowners for deficiency balances even in states where they are allowed to do so, preferring to use the loss as a tax write-off. I encourage people in this situation to discuss this with their mortgage holder and an experienced real-estate attorney prior to proceeding with a short sale. An experienced attorney should be able advise someone of their state's laws and may also be able to assist them in negotiating with their mortgage lender.
Generally speaking, it is common for it to take an individual up to two years after a short sale for a private lender to not count the short sale against the individual. With a foreclosure on the other hand, it can take up to five years before a lender will consider approving the person for a mortgage loan. Below I will discuss the difference between a short sale and a deed in lieu of foreclosure. I encourage you to read everything I've written here.
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 much lighter impact on a credit score.
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.
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. See the IRS document "The Mortgage Forgiveness Debt Relief Act and Debt Cancellation."
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 (although by no means exhaustive) list of 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?
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 is forgiven, typically.
However, recently Bills.com readers have reported that some mortgage companies are asking borrowers to agree 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.
Some lenders choose short sales because they do not want to own the distressed property. 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.
Debt distressing you? The Bills.com Debt Coach is a no-cost online tool that will analyze your debts and show you the options available to resolve them and the costs and benefits of each.
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.