Ask Bill your personal finance question

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.

Read full question
Bill's Answer
4.3
/5.0
(4 Votes)

Bills.com | Find Learn Save
Highlights

  • 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.

Best,

Bill

Bills.com

Get Mortgage Rates!
4.3
/5.0
(4 Votes)

People also like to Read

Betsalel Cohen

Mortgage programs have different minimum credit score requirements. However, lenders often have stricter rules. It is importa... Read more >>

Daniel Cohen

FHA Loans | FHA Loans have huge benefits, including VERY low down payments and low credit limits. Get FREE info on FHA loans... Read more >>

Betsalel Cohen

Mortgage Basics - Down-payment, Equity, and LTV | Learn about mortgage terms relating to your property's value and how it aff... Read more >>

Betsalel Cohen

Whether you are refinancing or buying a home you will ask yourself if you can afford the mortgage. Learn to prepare and evalu... Read more >>

Betsalel Cohen

Qualify for a Mortgage | You can get qualified for a mortgage and the best rates by preparing yourself. Make sure that your c... Read more >>

Mark Cappel

Applying for a mortgage with bad credit and a spouse isn't as difficult as you may think. Learn the what lenders look for whe... Read more >>

Betsalel Cohen

PMI | If you are looking to buy a house and take a mortgage loan with a low down payment then PMI can...... Read more >>

Brad Stroh

Refinance My Home? If you are asking 'Should I refinance my mortgage?' or 'Is refinancing my home a good?', then check out ... Read more >>

8 Comments

Recent Best
1500 characters remaining
  • ZS
    Jul, 2012
    Zoe
    Coweta, OK
    I'm considering a deed in lieu. We bought our house in 2006 for 100k, and still owe 93k on it. At the time my husband and I were both working full time jobs and had no other debt, the house payments were very manageable. We had a bad year in 2008, due to separation (we worked that one out) and depression, and we're now weighted down with overwhelming debt from medical bills, credit cards and loans. We really want to be unburdened with the house, and rent a cheaper home. The problem is that we have absolutely no savings, and are living frugally paycheck to paycheck just trying to scrape by. We have no money to put into the house to make it presentable for sale, no money for selling costs. We are very frustrated with feeling 'stuck,' and have considered foreclosure. Would deed in lieu be a better option for us?
    0 Votes

    • BA
      Jul, 2012
      Bill
      I recommend following two separate paths:
      1. Speak to your lender about a short sale or a deed-in-lieu of foreclosure. Check to see your state's anti-deficiency and non-recourse laws regarding your mortgage loan. You may need to negotiate a settlement regarding the short sale balance, but check into the HAFA program.
      2. Look into a debt relief program that will help you deal with your credit card and medical debt. You may find a credit counseling or a debt settlement program helpful.
      0 Votes

  • ML
    Apr, 2012
    Michael
    Euharlee, GA
    I am contemplating a short sale and/or deed in lieu of foreclosure. I was divorced about a year ago and left with the house. My ex-wife since then has purchased another house. We were unable to get her off the mortgage on the orignal house. What is the risk of her losing the house she currently owns (She has a mortgage)?
    0 Votes

    • BA
      Apr, 2012
      Bill
      First, see the Bills.com resource Remove a Name From a Joint Mortgage to learn your options for resolving this issue.

      Second, you mentioned your ex-spouse's liability for the mortgage of your house. Should you default on your joint mortgage, it will impact your ex-spouse's credit score. Also, your ex-spouse will endure collection calls. Should there be a foreclosure, your ex-spouse will have liability for the deficiency balance, should the lender chose to pursue one or both of you. If the lender files a lawsuit against your ex-spouse and wins, it could use the judgment to place a lien on your ex-spouse's property, levy bank accounts, and garnish wages.
      0 Votes

  • KG
    Jul, 2011
    karen
    Buffalo, MN
    Creative Financing needed. I have a contract for deed that is coming due and am not eligible for a loan due to a bankruptcy. My fiance would like to take out a loan and pay off the CD but the bank is requiring that my name be on the loan application Is there a type of loan that is available for this situation?
    0 Votes

    • BA
      Jul, 2011
      Bill
      You can look into loans that are made by private investors. Often these kinds of loans are secured by property. You can do a search online for 'private money loans' or 'hard money loans.' This kind of loan is usually going to come at a much higher interest rate than a conventional loan.

      You can also look at peer-to-peer lending, such as ones offered at Prosper or Lending Club.

      Lastly, your fiance may be able to qualify for the loan himself if he were on title to the property. Don't add him to the title without considering the risks of doing so and consulting with an attorney to discuss them.
      0 Votes

  • BB
    Feb, 2011
    Bob
    Tucson, AZ
    I had a 1st and 2nd mortgage with two different lenders, filed for chap 7 bankruptcy in April '10, house foreclosed in June '10. Received a discharge of all debts in July '10. Both loans were listed in bankruptcy. I got a 1099-A from first and the Fair Market value was about 6k higher than the principal. I haven't received anything at all from 2nd lender. I was told the 2nd lender charged off the loan.. but I still think I should be getting some kind of tax document from them. Any thoughts?
    0 Votes

    • BA
      Feb, 2011
      Bill
      I do not see a tax liability for you for either debt, but you may have circumstances that you did not mention that would change my analysis. Consult with your bankruptcy attorney about the 1099 issue. A financial institution is not required to file a 1099 for customers that had their debts discharged in bankruptcy, unless the debt relates to a business investment.
      0 Votes

loading...