Short Sale or Deed in Lieu: When You Owe More Than It Is Worth

If you owe more than the house is worth, an ordinary sale cannot complete. There is not enough money to pay the lender, and no title company will transfer a property with a mortgage still attached. The two routes out both require the lender to agree to something, and choosing between them depends on facts most people do not know they need.

This article covers what each route is, what the lender is actually deciding, which suits which situation, the deficiency question that matters more than either, and how long they take.

Establishing whether you are actually underwater

Start here, because people are frequently wrong in both directions.

What you owe is the payoff figure, not the balance on your statement. It includes arrears, late fees, legal costs and interest to a specific date, covered in our article on the seller's net sheet.

What the property is worth is what it would sell for, from sold comparables rather than an online estimate, and after the costs of selling.

A house that looked underwater at the balance is sometimes not underwater at the market. And a house that looked fine sometimes is, once arrears and costs are counted.

Work out the actual figure before assuming which conversation you are having, because if there is equity, neither of these routes is your answer and an ordinary sale is.

The short sale

What it is: selling the property on the open market for less than the payoff, with the lender agreeing to accept the proceeds and release the mortgage so the transfer can complete.

What the lender is deciding: whether accepting the shortfall now is better than foreclosing, taking the property, holding it, and selling it themselves at auction prices. Frequently it is, which is why these get approved.

How it runs

1. You apply to the servicer with a hardship package, similar to a loss mitigation application
2. The property is marketed and an offer obtained. Most lenders want an actual offer before deciding
3. The lender obtains its own valuation, frequently a broker price opinion or an appraisal
4. The file is reviewed and the lender approves, counters or declines
5. If approved, the sale closes on terms the lender set, including the net proceeds they require

The buyer problem: the whole thing takes months and the buyer has to wait through it. Many walk. A short sale needs a patient buyer, which narrows the pool considerably, and losing a buyer partway means restarting with a new offer and frequently a new valuation.

The deed in lieu of foreclosure

What it is: conveying the property to the lender voluntarily, by agreement, instead of going through foreclosure.

What the lender is deciding: whether taking the property now, without the cost and delay of a foreclosure, is better than proceeding. Sometimes it is and frequently there is a specific obstacle.

The obstacle that stops most of them

A lender taking a deed in lieu takes the property subject to whatever else is attached to it. A second mortgage, a HELOC, a judgment lien, a mechanic's lien, unpaid taxes.

Foreclosure, by contrast, generally extinguishes junior interests. So a lender facing a property with a second mortgage behind them frequently prefers to foreclose, because it clears the title in a way a deed in lieu does not.

Which means: if you have anything else recorded against the property, a deed in lieu is considerably less likely to be accepted. Check the record before you plan around it, covered in our county records guide and our article on mechanic's liens.

Comparing them honestly

• Control. A short sale keeps you involved and marketing the property. A deed in lieu hands it over
• Time. A short sale takes months and needs a buyer who waits. A deed in lieu can be faster where the lender agrees
• Junior liens. A short sale can address them by negotiation with each holder. A deed in lieu is frequently blocked by them
• Relocation assistance. Some programmes offer a payment to help a borrower move, on either route. Ask, because it is not always volunteered
• Effort. A short sale is considerably more work for you
• Certainty. A deed in lieu, once agreed, is more certain than a short sale that depends on a buyer staying

The question that matters more than the choice

Neither route automatically releases you from the shortfall.

A lender agreeing to accept less than the balance has agreed to release the lien so the property can transfer. Whether they have also released you from the remaining debt is a separate question, and it depends entirely on what the approval letter or agreement says.

Have an attorney read the approval before you accept it. This is the document that determines whether the matter ends or follows you, and it is covered further in our article on deficiency judgments.

The tax consequence people do not expect

Where debt is forgiven or cancelled, the cancelled amount can have tax consequences, and forms reporting it are issued in some circumstances.

There are exclusions that may apply, including relating to insolvency and to certain qualified principal residence debt. Whether any applies to you is a question for a CPA, and it is worth asking before you agree to anything rather than the following spring.

A homeowner who negotiates a deficiency release and then receives an unexpected tax bill has not had the outcome they thought they had.

Negotiating with junior lienholders

On a short sale with a second mortgage or other lien, each holder has to release for the sale to complete.

A junior lienholder facing a foreclosure by the first mortgage may recover nothing, which gives them a reason to accept a modest payment to release. First mortgage lenders frequently permit a limited amount from the proceeds for exactly this purpose.

It is negotiation and it takes time and it is frequently achievable. It is also a good reason to have somebody experienced handling the file rather than doing it yourself while also dealing with everything else.

How long they take

Both are slower than people expect and slower than a normal sale.

A short sale runs from application through marketing, offer, valuation, review and approval to closing. Months rather than weeks, and longer where there are junior liens or where a buyer walks and the process partly restarts.

A deed in lieu can be quicker once agreed, and getting to agreement takes time, and lenders frequently require the property to have been marketed first.

Which is why the timing matters. Neither route is a last minute solution. A homeowner starting either the week before a sheriff's sale is unlikely to complete it, and that is the single strongest argument for beginning early, covered in our article on what happens month by month.

Where we come in

Our interest, plainly, and it is more limited here than elsewhere on this site.

A short sale involving us needs the same lender approval as any other, and we cannot shortcut that. What we can do is be the patient buyer these transactions need: we do not have a rate lock, a moving date or a mortgage that expires, so we can wait out a lender review that a conventional buyer will not. That is genuinely the constraint that kills most short sales.

What we cannot do: make a lender approve anything, release a deficiency, or resolve a junior lien. Those are the lender's decisions and anybody suggesting otherwise is overstating.

And first: establish whether you are actually underwater. If there is equity, an ordinary sale is your route and it is a far better outcome than either of these, covered in our page on stopping foreclosure. And before any disposal, exhaust loss mitigation, because keeping the house at an affordable payment beats all of this.

The short version