The Difference Between Short Sale and Deed in Lieu of Foreclosure

Real Estate Broker/Owner with Showcase Realty LLC 183393

Homeowners who aren’t able to pay off their mortgage face a scary dilemma. This is especially true in times when home prices are declining while unemployment is on the rise. 


This means their mortgage payments are way higher than the value of their home, which takes away selling it  as an option. A foreclosure by the lender is usually the next step to this unfortunate situation. A lender will forcibly take ownership of the property , and the borrower is then evicted out of their home.


Fortunately, there are two solutions to avoiding foreclosure, losing your home and ruining your credit score:


Generally, creditors look at short sales and deeds in lieu of foreclosure more favorably than foreclosure. Short sales involve selling your home at a price less than your remaining mortgage, but unlike a foreclosure, the lender may agree to forego pursuing homeowner deficiency. 


In a deed in lieu of foreclosure, no sale takes place. Instead, the homeowner transfers the property title directly to the lender to release from mortgage obligation. 


In the end, though, the lender will have the final say on whether a short sale, deed in lieu of foreclosure, or a foreclosure is best. 


Their choice will depend on the risks involved and the status of the distressed property.


Today, let’s discuss how a short sale vs. deed in lieu of foreclosure works. We’ll also  compare the similarities and differences between these foreclosure alternatives.


From there, hopefully it will be clear to you if a short sale or deed in lieu of foreclosure is better if you’re ever in financial distress.

How are a Short Sale and a Deed in Lieu of Foreclosure Both Alike and Different?

A short sale and deed in lieu are alternatives to foreclosure. Both options remove a borrower’s mortgage obligations. However, the processes differ greatly:

  • Short sales involve selling a property at a lower market value approved by the lender
  • Deeds in lieu of foreclosure transfer property rights to the lender

While both are generally better choices than pushing through with a lengthy and frustrating foreclosure process, short sales and deeds in lieu share some similarities:

  • Loss of credit score: both will likely cause your credit score to drop. However, the drop won't be as grave as a foreclosure.
  • Deficiency judgment negotiation: both options allow borrowers greater leeway with deficiency amount negotiations. In some cases, lenders will remove your deficiency debt entirely.

Keep reading to learn more about their differences.

What is a short sale and deed in lieu?

To understand  the difference between a short sale and deed in lieu, we’ll discuss how each one works.

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What is a Short Sale?

A short sale happens when the homeowner (borrower) sells their property at a price lower than their remaining mortgage balance. 


The negotiation between the borrower and lender includes a minimum sale price for the short sale proposal to be approved. The lender, of course, wants to get as much from the sale as possible. It also wouldn’t be ideal, though if the property were to sit on the market for too long without mortgage payments.


In this scenario, the lienholder (lender) agrees to settle for the agreed-upon sales proceeds in exchange for releasing the borrower from their mortgage.

How Does a Short Sale Work?

The borrower must first get approval from the lender to start the short sale process. 


The first step of the short sale process involves completing a loss mitigation application. The application includes details about the borrower’s  expenses, income, and most importantly, their financial hardship.


Proving financial inability to pay the outstanding mortgage involves producing several documents, including:

  • Financial statement questionnaire (income and expenses)
  • Proof of income
  • Bank statements
  • Tax returns
  • Financial hardship statement or affidavit


Most banks will also require the short sale proposal to include an offer from the potential buyer. However, some lenders are more lenient with the purchase offer requirement.

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What are the Advantages of a Short Sale?Advantages to the Borrower

One of the biggest benefits of a short sale is the possibility of a waived deficiency amount. In this case, the short sale contract must explicitly state that the short sale fully satisfies the homeowner’s outstanding debt.


If waving the deficiency in its entirety isn’t possible, the lender may still agree to a reduced deficiency amount.


Compared to a foreclosure or deed in lieu of foreclosure, short sales have less impact on the borrower’s  credit history.


This is mainly because the borrower is the party that prepares for the home sale. In foreclosures, the lender has to prepare the home for sale, negatively affecting the borrower’s credit report.


Additionally, creditors will generally view short sales more favorably than foreclosures, because the borrower actively worked with the lender to resolve the issue.


Aside from being lengthy and burdensome, foreclosures cost a lot of money. 


On top of being unable to pay for their mortgage, homeowners who are forced into foreclosure may have to  pay as much as $7,500. These credit implications are enough to force most borrowers into bankruptcy.


Aside from that, it may be possible to recoup a part of their deficiency amount from sale proceeds. 


While short sales do involve a lot of negotiations and paperwork, they do  give homeowners an opportunity to take control of their finances. This is a manageable choice for most homeowners who don’t want to be at the mercy of their lender.

Advantages to the Lender

Most lenders will be happy to avoid the legal proceedings that come with foreclosure.


The foreclosure process involves lengthy court filings, hearings, and stacks of documentation that all take time and money to prepare.


Apart from that, the lender may choose to sue the borrower to recover the expenses involved with the foreclosure sale. This will only stack up the lender’s legal bills.


In the event of a foreclosure, the lender will also have to take on the responsibility of selling the home. 


As you very well know, selling a home involves spending a lot of time, money, and energy before the deal is closed.


Generally, foreclosed homes are less likely to be in a state of good repair. Due to that, they tend to spend a long time on the housing market , adding to lender expenses.


With a short sale, lenders are more likely to reduce total losses to a point where pursuing a deficiency amount isn’t necessary.

What are the disadvantages of short sales?

Unfortunately, not all homeowners have the privilege of going for a short sale or deed in lieu. 


Here are some of the limitations of the short sale process:


In the case where the property has multiple mortgages, all lien holders must approve the short sale proposal. Usually, the first mortgage holder will propose an amount to the second mortgage holder. The second mortgage holder can then approve or refuse the proposal to release the lien.


This is often the reason why homeowners with multiple mortgages on their home can’t proceed  with a short sale.


Homeowners cannot propose a short sale to their lender unless they have found a potential buyer.


While many buyers will be excited to find lower sale prices, some buyers are more reluctant with the short sale process. This is because it can be difficult to predict the lender’s reception of the short sale agreement.


In cases when a lender forgoes all or some of the deficiency amount, the homeowner may have to face tax liabilities. According to the federal income tax law, the loan forgiveness amount is considered as taxable income.


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What is a Deed in Lieu of Foreclosure? 

A deed in lieu of foreclosure involves directly transferring the title of the property to the lender. The lender will then try to recoup losses by selling the home to a new buyer.


In most cases, lenders will require homeowners to put the property up for sale for a few months. If the sale isn’t successful, the lender may agree to go forward with a deed in lieu of foreclosure.

How Does a Deed in Lieu of Foreclosure Work?

Just like a short sale, the deed in lieu process involves filing a loss mitigation application. 


Supporting documents will need to prove your income and expenses. Homeowners will also be required to present a copy of the listing agreement, the deed to transfer the title, and the estoppel affidavit.


The estoppel affidavit lays out the terms of the transfer agreement, including the homeowner’s deficiency judgment.

What are the Advantages of Deed in Lieu of Foreclosure?Advantages to the Borrower

Some homeowners might prefer a deed in lieu of foreclosure over a short sale. This is because a deed in lieu transfers the burden of selling the property from the borrower to the lender.


Especially if you’re in a financial crisis, you wouldn’t want to take on a challenge that is beyond your capacity. 


In some cases, lenders allow borrowers to lease the home for a certain period.


Apart from that, the borrower can avoid the unfortunate stigma that comes with a foreclosed home.

Advantages to the Lender

Generally, a lender will prefer a deed in lieu over a foreclosure.  


Mortgage brokers will prefer losing the deficiency amount to the borrower rather than paying the hefty legal fees associated with a foreclosure.


Apart from that, lenders can potentially earn a decent profit if a buyer is already interested in the property. Even if lenders put in little money to prepare the home for sale, earnings can be substantial in a hot real estate market.


However, most lenders will generally prefer a short sale over a deed in lieu.

What are the Disadvantages of Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure shares many of the same limitations as a short sale


For one, deeds in lieu are not possible if there are multiple mortgages involved in the property. A lender isn’t likely to approve the deed if there are numerous unpaid debts on a home.


A lender may also reject the deed in lieu if the home has a drastically lower value than the outstanding mortgage. 


Overall, getting a lender to agree with a deed in lieu of foreclosure is trickier than a short sale proposal. 

What is Worse for your Credit Short Sale or Deed in Lieu?

Most lenders prefer a short sale over a deed in lieu. 


This is because mortgage companies would rather get the payment in cash, rather than having to deal with a distressed property.


The lender will also have to take charge of the sale process, which can involve spending a lot of time and money on maintenance and negotiations.


For this reason, most lenders will offer lower credit deductions for short sales.

Which is Better, Short Sale or Deed in Lieu of Foreclosure?

Both short sales and deeds in lieu of foreclosure are better alternatives than foreclosure, which should be considered the last resort.


As I’ve said, foreclosures are long, expensive, and bloody for both parties –– homeowners and lenders.


While the final decision of whether you’ll go ahead with a short sale or deed in lieu rests on the lender, homeowners should still compare their differences against their financial needs.


Borrowers who prioritize keeping their credit scores up should  go with a short sale. Lenders and creditors are generally the most lenient with short sales, since the borrower is actively involved in the process.


Short sales also provide borrowers an opportunity to negotiate their deficiency balance.


On the other hand, homeowners who prefer not to be involved in the home selling process can transfer the property title to the lender. Deeds in lieu of foreclosure are also beneficial for homeowners who have had their homes on the market for more than three months.


However, it should be noted that lenders are generally more eager to deal with  a short sale over a deed in lieu of foreclosure.


A short sale and deed of foreclosure will remove the possibility of having to go  through the foreclosure process.


Unfortunately, there is still a negative stigma that surrounds foreclosure. This can negatively affect your credit report in huge ways.


Being evicted from your home removes your dignity to make decisions about your property.


Apart from that, the foreclosure process is generally long and frustrating. In the months or years it takes to complete the foreclosure, your lender may get in touch with you to complete your mortgage payment.


Generally, either a short sale or deed in lieu of a foreclosure is a better choice than settling with foreclosure.


Homeowners who would prefer to be actively involved in selling their home can settle on a short sale agreement that is light on their deficiency amount and credit histories.


On the other hand, homeowners who find it difficult to sell their homes can propose a deed in lieu of foreclosure.


In the end, the lender will make the final call on whether a short sale or deed in lieu of foreclosure is less risky.


Homeowners who face the daunting possibility of a foreclosure can get in touch with me, Nancy Braun at 704-997-3794. Rest assured that I can lay out all possible options so that you can make it out of this challenging financial situation with dignity.


Posted by

Nancy Braun

Owner & Broker in Charge

Showcase Realty,LLC


1430 S Mint St Suite 106

Charlotte, NC 28203


704-625-2361 (f)

Comments (8)

Wayne Martin
Wayne M Martin - Chicago, IL
Real Estate Broker - Retired

Good morning Nancy. Great synopsis of a complicated issue. Those in a predicament should seek competent counsel. Enjoy your day.

Jan 08, 2022 05:10 AM
Bill Salvatore - East Valley
Arizona Elite Properties - Chandler, AZ
Realtor - 602-999-0952 / em:

I so hope this market never comes back.  Hope you have a relaxing weekend.  Thanks again for the post.  Time to get out and shovel, oh wait I live in Phoenix, sunny and 70 degrees today. bill

Jan 08, 2022 05:36 AM
Rocky Dickerson
Realty One Group - Las Vegas, NV
Superior Service!

Luckily, in my area, homes went up over 20% last year. Nobody is lacking in equity so they can avoid short sales and foreclosures

Jan 08, 2022 02:41 PM
Ed Silva
Mapleridge Realty, CT 203-206-0754 - Waterbury, CT
Central CT Real Estate Broker Serving all equally

Quite a detailed post but for someone facing a distressed issue it carries the information needed to make an informed decision

Jan 15, 2022 06:14 AM
Dorie Dillard Austin TX
Coldwell Banker Realty ~ 512.750.6899 - Austin, TX
NW Austin ~ Canyon Creek and Spicewood/Balcones

Good morning Nancy Braun ,

I'm so glad that Carol Williams featured your post in her Second Chance Saturday series as I missed it! What a detailed report which shows if you are facing the dilemma of not being able to pay  off your mortgage you have options but need to seek assistance. Our property values have escalated so much in the last 2 years there is virtually no foreclosures or short sales now or in the near future. 

Jan 15, 2022 06:50 AM
Hannah Williams
HomeStarr Realty - Philadelphia, PA
Expertise NE Philadelphia & Bucks 215-820-3376

Nancy Braun  Very long, detailed post with good information to help a stressed person in crisis  so glad Carol Williams  featured this post as I missed it  Great info 

Jan 15, 2022 10:06 AM
Aura Alex
CloseMyDeal, LLC - Seattle, WA
Need A TC? Virtual TC Services Nationwide

Hello, Nancy Braun; thank you for sharing your experience and knowledge. I spent most of my time during 2007-2015 teaming up with a few real estate attorneys in Cleveland, OH, to assist distressed homeowners. I am glad that this stressful process is now not so much, and I hope the market stays this way. If I may add, one thing was dealing with the junior lien holders as we had lost many short sales and DIL deals due to these junior lienholder sharks! 

Jan 15, 2022 10:36 AM
Grant Schneider
Performance Development Strategies - Armonk, NY
Your Coach Helping You Create Successful Outcomes

I am just wondering how many of these exist in these times given the rising value.

Jan 15, 2022 11:18 AM