Short Sales and Deed in Lieu of Foreclosure
Foreclosure Options Outside of Bankruptcy
Homeowners that can no longer afford their mortgage payments face several choices in how to deal with their debt. The options of deed in lieu of foreclosure or short sale are available to some homeowners, allowing bankruptcy to be an option of last resort. Although these options are similar, there are important differences and the benefits they can provide.
A deed in lieu of foreclosure is just as the name implies – the property owner deeds the property to the mortgage holder in a voluntary exchange for the mortgage holder to cancel the loan and not foreclose on the property securing the mortgage. If foreclosure proceedings have already been initiated, the lender promises to terminate this proceeding. With a deed in lieu, the lender may or may not agree to forgive any deficiency owed by the property owner for property.
One downside of a deed in lieu of foreclosure is the tax implication for forgiveness of any deficiency balance. Under federal law, a creditor is required to file a 1099C whenver it forgives a loan balance greater than $600. If the lender agrees to forgive any deficiency along with a deed in lieu, a tax liability may be imposed because the forgiven debt is treated as “income” for tax purposes. However, the Mortgage Forgiveness Debt Relief Act of 2007 provides tax relief for some loans forgiven between 2007 and 2013. Before you enter into a deed in lieu, be sure to read the agreement carefully to see how it treats deficiency balances.
Another limitation of a deed in lieu of foreclosure is that it can only be entered into if there is one mortgagor. If a property owner has two mortgages from different companies he cannot deed the property to the first mortgage holder without removing the second mortgage first.
In a short sale, the lender agrees to accept less than the balance owed on the mortgage sale. The deficiency balance may or may not be forgiven. Unlike a deed in lieu of foreclosure, the ownership of the property is not transferred to the mortgage holder, instead it remains with the owner. Lenders accept short sales because they do not want to own distressed properties. Lenders would rather see the owner sell the property and lose the deficiency balance than be forced to take the property through legal proceedings and then sell the property themselves.
Like deeds in lieu of foreclosure, a lender is required to file a 1099C if the debt forgiven exceeds $600. Again, the Mortgage Forgiveness Debt Relief Act offers former homeowners tax relief for debt forgiveness.
Both deeds in lieu of foreclosure and short sales usually require the following:
1) the property must already be on the market for a certain number of days (90 days is typical),
2) there can be no other liens on the property,
3) the property cannot already be subject to legal proceedings,
4) the offer of a deed in lieu must be voluntary,
5) for a short-sale, the seller must have a hardship, and
6)the house must be priced reasonably.
If a lender will not accept either a deed in lieu of foreclosure or a short sale, bankruptcy may be the last option for a property owner. Generally speaking, deficiency balances are treated like any other unsecured debt in bankruptcy, meaning they are discharged in both Chapters 7 and 13.