As a former real estate agent with friends who find themselves unable to pay on their mortgages, I am frequently asked what if any alternatives there are to foreclosure. There are two alternatives to foreclosure, Deed in lieu of foreclosure and Short sale. Because a foreclosure is so devastating to a consumer’s credit score, almost anything is better than going through a foreclosure, and both of these alternative options result in a lighter impact on your credit score. Considering the situation most homeowners find themselves in today needing some help with debt.
A Deed in lieu of foreclosure and a short sale are very similar, but there are some key differences that depend on the specifics of your situation. By comparing and contrasting both of these, one can determine which option is better, if they are made available to you by your lender.
Let’s first answer the question, what is a Deed in lieu of foreclosure? A Deed in lieu of foreclosure is an alternative to foreclosure offered by some lenders. In a Deed in lieu of foreclosure, the property owner gives the property via the deed, to the lender voluntarily in exchange for the lender canceling the loan. The item exchanged in the transfer is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any proceedings already underway in the process. The lender has at his discretion, the power to forgive any remaining balance that result from the sale of the property. This remaining balance, which is the difference between the amounts owed minus the amount sold for, is known as a deficiency balance.
A huge side effect to a Deed in lieu of foreclosure, is the possible forgiveness of the deficiency balance. Under federal law, a lender is required to file a 1099C with the Internal Revenue Service whenever it forgives a loan balance greater than $600. This may in fact create a tax problem for the former property owner. The IRS considers this forgiven balance as taxable income. However, the Mortgage Debt Relief Act provides some tax relief for consumers with loans forgiven in the years 2007 through 2012, and provide help with debt. Always consult with a tax professional when dealing with the IRS, as my debated expertise lies solely with mediocre fish tacos, their preparation, and consumption as a competitive sport.
The point to remember in a Deed in lieu of foreclosure is whether the lender is willing to forgive the deficiency balance. Always read the contract carefully to determine how the balance issue is to be resolved. If the contract is vague, take it to an attorney with experience in property law. Most lawyers are very expensive, but compared with the possibility of signing an agreement you do not understand could be worth the cost.
The next option for consideration is a short sale in which the lender agrees to discount a loan balance. The home owner sells the mortgaged property for less than the outstanding balance of the loan, and the lender agrees to accept less than the balance owed on the mortgage at sale. The deficiency balance is forgiven, typically. Unlike a Deed in lieu of foreclosure, the ownership of the property is not transferred to the lender and remains with the owner. Some lenders choose Short sales because they do not want to own the distressed property. They would rather see the owner sell the property and lose the deficiency balance than be forced to take the property through foreclosure, as it 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 weighs its risks and how state and local laws determine the outcome. Again, as mentioned before, the lender is required to file a 1099C with the IRS for any forgiven debt. Remember, the Mortgage Forgiveness Debt Relief Act offers former homeowners relief for forgiven debt.
The question then arises, what if the lender will not allow a short sale or a deed in lieu of foreclosure? Foreclosure auctions tend to bring significantly less money than a normal sale and could take quite a long time and you may still have to pay the balance even years after the transaction. As with most of my humble advice, especially when dealing with huge amounts of debt, I urge you to consult with a bankruptcy attorney to fully understand all of the options in helping to resolve your mortgage debt. Keep researching and do not give up, remember what does not kill you only makes you stronger.