Loan Modification, Deed in Lieu & Short Sale Compared
I live in Illinois and have two properties In Florida. Should I do a loan modification, deed in lieu, or a short sale?
I live in Illinois and have two lots in Florida on which I have interest only mortgages (two separate lenders). I owe $361k on one and market value on this has dropped down to $250k or less. On the second lot I owe $309k, and market value also has dropped to high $200s. There has been no sale in the area for last 18 months. I have a balloon payment on both that will be due in 12 months. So far I have paid mortgage and property taxes. However, I have not been able to save any money due to overextending myself when I bought the properties. I will not be able to make any balloon payments. I am trying to understand what my best options are between loan modification versus deed in lieu versus short sale.
- Examine how a deed in lieu of foreclosure works.
- Compare a short sale to a deed in lieu.
- Pay close attention to the tax implications of any forgiven debt.
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.
Generally speaking, a loan modification is the recommended solution. However, in your situation it might not be an affordable alternative. In this case you may strongly want to consider a short sale on each of the properties mentioned. Below I will compare and contrast deed in lieu vs. short sale.
What is a Deed in Lieu of Foreclosure?
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 1099-C 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 2009. 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.
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.
I hope this information helps you Find. Learn & Save.