Short Sale vs. Deed in Lieu of Foreclosure: Which is Better?
The Law Office of Marc G. Alster advises homeowners in Hackensack and across northern and central New Jersey, as well as in nearby New York counties. Drawing over 30 years of bankruptcy experience, Attorney Marc G. Alster helps you evaluate how each option may affect your property, remaining mortgage debt, and broader financial situations.
What Is the Difference Between a Short Sale and a Deed in Lieu?
A short sale involves selling a property for less than the total mortgage debt. Because the sale proceeds will not be sufficient to payoff the mortgage loan; the mortgage lender must pre-approve the reduced payoff and agree to release its lien on the property. Other junior lienholders whose claims cannot be paid in full will also need to approve the transaction.
A deed in lieu of foreclosure transfers ownership directly to the mortgage lender. No third-party buyer is needed. In return, the lender typically agrees to accept the property in full satisfaction of the mortgage debt in order to avoid having to file and prosecute a foreclosure action against the property.
A deed in lieu of foreclosure is typically the preferred option, as it removes the uncertainty of trying to find a short sale buyer and is much easier and quicker. The practical choice often depends on how many other liens affect the title to the property, how quickly the homeowner needs to leave, and whether the mortgage lender will waive the unpaid balance owed.
A deed in lieu of foreclosure is also better when a sale is unlikely, and/or the property owner needs a quicker and more direct exit. Both require lender approval and may create credit and tax consequences; in this attorney's opinion either option should never leave the homeowner with a deficiency balance owed to the mortgage lender, which the homeowner cannot afford to pay. A short sale is necessary if you cannot negotiate a quick deed in lieu of foreclosure and either the mortgage lender or junior lienholders will not provide written forgiveness of their mortgage or other junior liens through a deed in lieu of foreclosure.
How Do a Short Sale and Deed in Lieu Compare?
A short sale requires a qualified buyer, while a deed in lieu transfers the property directly to the lender.
A deed in lieu will likely be the better fit when:
the subject property cannot be sold through regular channels due to insufficient equity allowing Lienholders to be paid in full from the proceeds of the closing.
The homeowner needs a quicker and more direct transfer, and the mortgage lender and junior lienholders agree to accept the deed and release their mortgage and/or other secured debt.
The property has no junior liens or significant title problems, which would negate the ability to do a deed in lieu of foreclosure.
A short sale may be the only or better alternative fit when:
The lender requires and there is enough time to market and procure the mortgage lenders review and approval of the short sale.
The property is likely to attract a buyer.
Other junior lienholders, if any, are willing to release their claims, which will be necessary to effectuate/close the sale only a short sale is conducted.
Both options require the lender’s approval. In either case, the written agreement should clearly state whether the mortgage lender agrees to forgive the remaining balance and waive any remaining balance after accepting the agreed to amount from the proceeds of the short sale.
What to expect when trying to get a Short Sale approval?
The lender will usually examine the proposed sale price, current property value, closing costs, financial hardship, and recovery that can be expected to be realized through a foreclosure sale (as opposed to through a short sale). The lender will likely request bank records, tax returns, income information, a hardship letter, and the buyer’s contract before approving the transaction.
Additional tax liens, junior mortgages, judgment liens, condominium, and any other junior secured liens can delay or prevent closing. Each of the above described, lienholders, if any, must agree to release their liens, often in exchange for part of the available proceeds, before a short sale can be effectuated/closed.
Most important to realize is that approval of the sale does not automatically forgive any remaining unpaid debt owed to the mortgage lender. The approval letter should clearly state whether the secured lender waives the deficiency and accepts the proceeds as full satisfaction of its secured loan. It usually does not make sense for a property owner to conduct a short sale unless the lender agrees to waive the deficiency balance after payment of the agreed to amount from the short sale proceeds. Sometimes a lender will even agree to pay a sum for the debtor's relocation assistance and related costs in return for the property owner leaving the property in good condition and otherwise cooperating with the mortgage lender.
When Is a Deed in Lieu Usually Better?
A deed in lieu may be preferable when the property has not sold through regular channels, the homeowner has little or no equity in the property, and a direct transfer can be done to avoid a foreclosure faster. It removes the need to locate a buyer but still requires the lender’s voluntary agreement.
Clear title is often essential. A lender may reject a deed in lieu if a second mortgage, tax lien, judgment, or other claim would remain attached to the property after the transfer. Property damage, an advanced foreclosure case, or restrictions imposed by the loan’s investor may also affect approval.
The agreement should state that the lender accepts the deed in full satisfaction of the mortgage debt if that is the negotiated result. It should also address dismissal of any pending foreclosure case, the move-out date, property condition, personal belongings, and possible relocation assistance. Transferring the deed without clear deficiency release language can leave uncertainty about further collection.
How Do New Jersey and New York Laws Affect the Choice?
New Jersey and New York both use judicial foreclosure, but their procedures differ. State law and the negotiated agreement all affect the homeowner’s remaining liability.
Under New Jersey’s Fair Foreclosure Act, a residential mortgage servicer that receives a good-faith short-sale offer must generally approve it, deny it, or request additional information within 60 days. This response requirement does not force the lender to approve the sale.
New Jersey law also recognizes an optional foreclosure procedure involving a deed in lieu. When that specific statutory procedure applies, the deed must clearly disclose a limited right to rescind the conveyance within seven days, excluding Saturdays, Sundays, and legal holidays.
New York foreclosure settlement conferences may address short sales, deeds in lieu, loan modifications, and other loss-mitigation options. New York court guidance states that a deed-in-lieu agreement should specify that the transfer fully satisfies the debt, so the borrower is not exposed to a deficiency judgment.
The Foreclosure and Deficiency statutes and rules which differ between the states do not replace the need for clear release language in a voluntary short sale or deed-in-lieu agreement.
Which Option Is Better for Credit?
A short sale and a deed in lieu can both cause substantial damage, especially when the mortgage already shows missed payments.
The effect on property owners credit scores depends on how the lender reports the account, the borrower’s prior credit history, the scoring model, and the requirements of a future mortgage program. Neither transaction removes earlier delinquencies. Future loan eligibility may also depend on the reason for the default and the time that has passed.
Credit impact should not be considered in isolation. A modest negative impact on your credit score may be overshadowed by the positive impact of obtaining a written release from a large deficiency or avoiding additional months of missed payments and foreclosure expenses.
Can Either Option Create Tax Liability?
A short sale or deed in lieu can create tax consequences because the transfer may count as a disposition of property and forgiven debt may be taxable cancellation-of-debt income.
The result depends in part on whether the type of property, and whether a federal exclusion applies. Bankruptcy, the property owner's insolvency, or another tax provision may exclude some canceled debt, thus eligibility is fact-specific.
A lender may issue Form 1099-C for canceled debt or Form 1099-A following the acquisition or abandonment of secured property. The form does not by itself determine the final tax owed. A tax professional should review the proposed transaction before signing, particularly when the lender will forgive a substantial balance.
Could Bankruptcy Be a Better Alternative?
Bankruptcy may be a better option when mortgage arrears are part of a broader debt problem. A short sale or deed in lieu addresses the property and mortgage, and hopefully any deficiency balance, but it does not resolve credit cards, medical bills, personal loans, judgments, or other obligations.
A bankruptcy filing generally activates a temporary stay that stops most collection activity, including foreclosure, subject to statutory exceptions and later court orders. Chapter 7 and Chapter 13 generally discharges personal liability for mortgage debt and provide relief from other debts, if successfully completed.
Comparing bankruptcy with loss-mitigation options before transferring the property can prevent unintended results. The analysis should consider income, assets, home equity, other liens, prior bankruptcy cases, and whether the homeowner wants to keep or surrender the property.
What Should a Homeowner Review Before Signing?
The most important issue is not simply whether the transaction is called a short sale or deed in lieu. The written agreement should explain whether the lender forgives all/any deficiency balance owed on the mortgage and waive all further collection efforts against the property owner.
A homeowner should also consider and look into tax consequences, credit reporting, closing expenses, surrender terms, and possible relocation assistance. Verbal statements from a mortgage servicer are not a substitute for written terms approved by the lender or loan investor.
Bankruptcy Attorney in Hackensack, New Jersey
Attorney Alster has represented debtors and creditors for over 30 years in the United States Bankruptcy Court for the District of New Jersey and the Southern and Eastern Districts of New York. He personally evaluates each client’s circumstances and develops a plan suited to the client’s financial situation.
Attorney Alster limits his caseload so he can provide direct attention throughout each matter. The Law Office of Marc G. Alster serves Hackensack and Bergen, Passaic, Hudson, Essex, and Union counties in New Jersey, as well as Rockland, Westchester, Orange, and Putnam counties in New York. If you’re a homeowner considering a short sale, deed in lieu, or bankruptcy, contact the firm to discuss your options.