Short Payoff and Short Sale: They Are NOT the Same

The terms short payoff and short sale are sometimes used interchangeably. But they’re not the same thing. A short payoff is a solution for homeowners who are current on their mortgage and have the financial ability to continue to pay but who want to leave their homes. A short sale is a loss mitigation option homeowners can use if they’re facing financial hardship and are in danger of defaulting their mortgage. In both scenarios, the home’s market value is less than what the homeowner owes on the mortgage, but each is used in different scenarios and has different consequences. This article with dive into both of these topics.

What Is a Short Payoff? 

In a short payoff, the lender agrees to let the borrower sell the home for less than what they owe on the mortgage loan. The lender must first agree to the short payoff because it has an interest, or lien, on the property. If the lender agrees, the borrower can sell the property, but they’ll have to pay the deficiency. This is the difference between the amount they owe on the mortgage and the sale price. Once the property is sold, the borrower must pay the deficiency either in a lump sum or in payments with a new unsecured loan or promissory note.

Borrowers who do short payoffs get rid of their homes and move on without damaging their credit. Since short payoffs don’t hurt your credit score, doing one doesn't get in the way of purchasing another property down the road. Also, if you get an unsecured loan to pay off the remaining balance or deficiency, it will generally have a low interest rate. This is why if you’re up to date on your mortgage payments and would prefer to let go of your house, a short payoff can be a good option. 

That said, not all lenders will agree to a short payoff, and the procedure can be hard to negotiate. Also, if your lender forgives any of the debt you owe, you may be liable to pay taxes on that amount. Debt forgiveness — also called debt cancellation — is when a lender writes off debt and the borrower is no longer responsible to pay it back. If the canceled debt exceeds $600, the borrower must report the debt as ordinary income for tax purposes. 

When Is a Short Payoff a Good Idea?

A short payoff can be a good option for you in the following cases:

• The house's fair market value has dropped significantly. If the mortgage is underwater and you owe more than the current market value of your property, your home has become a bad investment. 

• You want to move away from the property, but the market value has dropped. If you didn’t want to move away, you could wait until the housing market changed and you were no longer underwater on the mortgage.

• You can make the mortgage payments but don't have enough money on hand to cover the deficiency amount. In this case, a repayment plan with your lender can help you pay off the deficiency over time.

Borrowers will need to meet certain criteria to be eligible for a short payoff with their lender, including:

• You must show that you’re able to pay off the debt.

• You must be current on the original mortgage.

• You must have good credit and a steady income.

If you meet all of these criteria, then it may be worth talking to your lender to see if they’ll allow you to do a short payoff.

What Is a Short Sale?

A short sale is one way for homeowners to avoid foreclosure. It’s one of several loss mitigation options homeowners have if they’re struggling to pay their mortgage. Other popular loss mitigation options are a deed in lieu of foreclosure, a refinance, or a loan modification. Like a short payoff, short sales also require the lender's approval. 

In a short sale, the homeowner voluntarily sells the house for less than what they owe on the mortgage. This results in a sale price that is short of the balance due, which is how this gets the name short sale. It’s also why it requires the lender’s approval. If the lender agrees to a short sale, they will accept the sale amount, release the mortgage lien on the property, and usually forgive the remaining balance owed. In exchange, the lender gets all the sale proceeds.

For example, say Leila owes $250,000 on her house and can find a buyer who will pay $210,000. Leila requests a short sale from her lender as the sale price is short of the full loan balance owed by $40,000. If the lender accepts the short sale, they release the borrower from the mortgage. If the lender has agreed to forgive the deficiency — the $40,000 — the borrower may have to pay taxes on it.

When Is a Short Sale a Good Idea?

A short sale may be a good option if you're facing a foreclosure or can't pay your mortgage. Generally, lenders consider many factors when evaluating a borrower's short sale application. As part of the process, an independent appraiser will determine the fair market value of the home and real estate.

Lenders are most likely to accept a short sale if the house's market value has dropped significantly. Also, the homeowner must be in default or likely to go into default soon and must be able to prove they’ve experienced economic or financial hardship. The homeowner must also have few or no assets that can be used to pay off the debt. It is important that the homeowner put together a proper short sale package and include a hardship letter indicating why they’re requesting a short sale.

Consequences of Short Sales 

Lenders may agree to waive the deficiency amount as part of the short sale agreement, or they may require the original borrower to pay back some or all of the deficiency. If the lender forgives any of the deficiency, you might be liable to pay the IRS taxes on the forgiven amount. 

If the short sale agreement doesn't include a waiver, some states will allow the lender to seek a personal judgment against the original borrower after the short sale to recover the deficiency amount. Once a lender obtains a deficiency judgment from the court, it can collect the amount using whatever methods are allowed in your state. Some states, like California, don’t allow deficiency judgments following a short sale in certain circumstances. 

After a short sale, your credit score will take a hit. The damage will be less than a foreclosure sale, but it can still knock off over 100 points from your credit score. The extent of the damage will be determined by several factors including your credit standing at the time and the amount the lender received in the sale of the house. A short sale is listed on your credit report as a charge-off, a settlement, a deed-in-lieu of foreclosure, or as "settled for less than the full amount due."

Let's Summarize…

If you’re struggling to pay your mortgage, you can ask your lender about loss mitigation options, including a short sale. Short sales are for financially distressed borrowers who have experienced financial hardships and are in danger of defaulting on their mortgage. If you can pay your mortgage but your home has lost value and you want to move, you can ask your lender to approve a short payoff. While these terms are sometimes used interchangeably, they are not the same thing. That said, both require the lender’s approval and can result in tax consequences or a need to pay a deficiency balance.