What's the Difference Between Short Sale and Deed in Lieu of Foreclosure?

If you're having difficulty affording your home during hard economic times, you may be able to avoid foreclosure through either a short sale or a deed in lieu of foreclosure. While neither option is as desirable as staying in your home, they do at least help you avoid the costs and hassles associated with foreclosure.

What is a short sale?

A short sale is the sale of your home for an amount less than the amount you still owe on your mortgage. The sale does not have to be to your lender, but your lender must agree to it. Borrowers choose this option when they cannot afford to continue making monthly mortgage payments and cannot pay the difference between the sale price and the unpaid mortgage amount. However, the borrower is not freed from his obligation to repay the remaining mortgage balance unless the lender agrees. Many lenders require that disadvantaged borrowers provide proof of economic or financial hardship before agreeing to a short sale.

• Advantages of a short sale:
  • You no longer have a mortgage payment.
  • You can buy another home in two years, rather than five to seven years if you foreclose.
  • You save yourself the costs and fees usually associated with foreclosure.
• Disadvantages of a short sale:
  • Your credit report may be damaged if your lender reports the short sale to credit monitoring agencies.
  • If you owe money to more than one creditor (for example, if you have taken out second and third mortgages on your property), they will also have to agree to the short sale because they, too, will be paid an amount less than what you owe them.

What is a deed in lieu of foreclosure?

A deed in lieu of foreclosure transfers ownership of your home to your lender to pay off your loan and avoid the foreclosure process. Prior to an ownership transfer, the lender and borrower must enter into a settlement agreement including a sale price at least equal to the home's fair market value. The borrower must also enter into the settlement agreement voluntarily and may be required to provide written proof he's doing so.

• Advantages of a deed in lieu of foreclosure:
  • It completely satisfies your loan obligation.
  • Your credit rating is not as damaged as it is by a foreclosure.

However, issues arise when the property has more than one lien holder. If you have outstanding judgments or other unpaid mortgages, your lender would be assuming responsibility for payment of these outstanding obligations if it purchases your home by deed in lieu of foreclosure. Under these circumstances, your lender may wish to foreclose on your home in order to wipe these liens out.

Deed for lease or mortgage to lease

Another alternative to foreclosure is “deed for lease” or “mortgage to lease.” This rent-back program was introduced in 2009 by Fannie Mae; banks are trying to implement their own programs.

The rent-back idea is tied to the deed in lieu of foreclosure program — the lender would have to agree to let the defaulting borrower stay in the home as a renter for one to three years. Not everyone qualifies for this program, since it would be at the discretion of the lender.

Bottom line

If you're having trouble making your mortgage payments, discuss these options with your lender as soon as possible. It could save you the time, trouble and hardship of going through the full foreclosure process.