If you can’t afford your mortgage payments and are ready to give up your home, then you might be able to avoid a foreclosure—and perhaps a deficiency judgment—with a short sale or deed in lieu of foreclosure. In addition to potentially avoiding a deficiency judgment, another upside to completing either of these options is that you won’t have a foreclosure as part of your credit history. The downside is that a short sale or deed in lieu of foreclosure is almost as bad as a foreclosure when it comes to your credit. Though, for some people, not having the stigma of a foreclosure on their record is worth the effort of working out one of these alternatives. Also, another upside is that some banks offer relocation assistance—often a thousand dollars or more—to help homeowners find new housing after a short sale or deed in lieu of foreclosure.
Read on to get the lowdown on how short sales and deeds in lieu of foreclosure work.
Short Sales: Sell Your Home for Less Than You Owe
If your mortgage is “underwater”—meaning you owe more on the loan than your home is worth—then a short sale might be a good way for you to avoid a foreclosure. (If you have equity in your home, on the other hand, you can sell it to a new owner and pay off the bank in full.)
How to apply for a short sale. To do a short sale, you must submit a loss mitigation application to your mortgage servicer, which is the company you make your monthly payments to. The application is usually in the form of a “Request for Mortgage Assistance” (RMA) questionnaire. The RMA asks for information like:
- the hardship that caused you to fall behind in your mortgage payments
- your monthly income and expenses
- your assets
- whether there are other mortgages or judgment liens on your home, and
- information about any other properties you own.
You’ll also probably have to provide supporting documentation like pay stubs and bank statements.
Sometimes, a bank requires a homeowner to have an offer from a potential purchaser when submitting a short sale application—but not always. (If you want to complete short sale, contact your mortgage servicer to find out if your bank requires a purchase offer along with an application.)
Deficiency judgments after short sales. With a short sale, the bank might waive (give up) its right to a deficiency.
But if the bank doesn't waive the deficiency as part of the short sale, most states allow the bank to file a lawsuit afterwards to get a personal judgment—a deficiency judgment—against the homeowner.
For example, suppose Mr. and Mrs. Smith purchased a new house in 2014 for $300,000. At that time, Mr. Smith was a stay-at-home dad and Mrs. Smith worked in advertising. A few years later, Mrs. Smith lost her job and the couple couldn't make the mortgage payments anymore. Because the house was worth only $275,000—and the Smiths still owed the bank $300,000—the Smiths asked for permission to sell the property for $275,000. The bank approved the short sale, but did not waive the deficiency, and the home was sold to a new owner. A few months after the sale, the bank filed a lawsuit in court against the Smiths and got a deficiency judgment in the amount of $25,000.
Deed in Lieu of Foreclosure: Give Your Home to the Bank
Another way to avoid a foreclosure is by completing a deed in lieu of foreclosure. In a deed in lieu of foreclosure transaction, a homeowner voluntarily hands over the home's title to the bank in order to satisfy the mortgage loan.
Banks sometimes require that homeowners attempt to sell the property for at least 90 days at fair market value before allowing a deed in lieu of foreclosure. Also, the property ordinarily must have clear title, which means there can't be other liens on the home.
How to apply for a deed in lieu of foreclosure. As with a short sale, to get a deed in lieu of foreclosure you have to submit a loss mitigation application to your mortgage servicer. Again, the servicer will probably require a completed RMA form. (Servicers use this form when evaluating borrowers for short sales and deeds in lieu of foreclosure, as well as other foreclosure avoidance options like modifications.)
Deficiency judgments after deeds in lieu of foreclosure. In a deed in lieu of foreclosure transaction, the deficiency is the difference between the fair market value of the home and the total mortgage debt. Generally, a bank will agree to let a homeowner off the hook for a deficiency with a deed in lieu of foreclosure—but not always. If a deed in lieu of foreclosure agreement does not contain language expressly stating that the transaction is in full satisfaction of the debt, the bank might later file a lawsuit to get a deficiency judgment.
Avoiding a Deficiency Judgment
A few ways that you might be able to avoid paying all or part of the deficiency after a short sale or deed in lieu of foreclosure are by:
- Asking the bank to waive the deficiency judgment. As part of the short sale or deed in lieu of foreclosure process, you can ask the bank to waive its right to a deficiency judgment—even if the bank doesn't volunteer to waive the deficiency upfront. Banks sometimes agree to waive the deficiency after a request, particularly if you don't have a lot of money in the bank or other assets that could be used to pay off the debt. If the bank agrees, be sure to get the waiver in writing.
- Settling the deficiency for a lesser amount. If the bank won't agree to waive the deficiency altogether, it might agree to accept a lesser amount than you actually owe in satisfaction of the debt. Because a bank has to file a lawsuit to get a deficiency judgment, it's sometimes possible to convince the bank that it would be easier and cheaper to accept a smaller amount rather than going to court. Again, be sure to get the agreement in writing.
- Filing for bankruptcy. You might be able to discharge (eliminate) your liability for the deficiency by filing for bankruptcy.
If you need help arranging a short sale or deed in lieu of foreclosure, consider talking to a HUD-approved housing counselor. A housing counselor can also provide information about other ways to avoid foreclosure, such as a forbearance agreement, repayment plan, or modification, like a Fannie Mae or Freddie Mac Flex Modification.
To find out if bankruptcy will help in your situation, consult with a bankruptcy attorney.