In an earlier post, Short Sale v Foreclosure, we saw the difference between a short sale and a foreclosure, but there is another option for a distressed homeowner. This is the Short Payoff. This option makes sense only under special circumstances.
What’s the difference between Short Sale v Short Payoff?
In our current real estate environment, short sales are becoming more common. A short sale occurs when the lender or investor agrees to accept an amount less than actually owed on the property. The lender sells the property “short.” In this case, it’s up to the homeowner, usually using a real estate agent, to market and sell the property. The new buyer usually gets a bargain. The previous homeowner gets out from under an unmanageable mortgage by giving up the house.
In order to qualify for a short sale, generally speaking, the homeowner must demonstrate a verifiable long-term hardship rendering him unable to pay the mortgage. These days, many homeowners, especially those who bought within the last several years or those who refinanced and took big chunks of equity out of their properties, becoming “upside down” in their home loans or owing more than the home is worth. Now, more and more often, these homeowners are also doing short sales.
So far, this doesn’t sound like such a bad deal. The house I bought loses value, so I sell it at current market rates and the lender takes the loss. Well, true, but the homeowner no longer has a home. And, the former homeowner will probably be a renter for several years to come as his credit report’s FICO score will immediately drop by about 300 points. The newest loan guidelines from Fannie Mae and Freddie Mac specify that after a short sale, a prospective borrower must wait for 2 years to qualify for any FHA- or government-backed loan.
So, what’s the alternative that will NOT damage credit to such a degree?
That option is called a Short Payoff. It also carries some tough restrictions. If the homeowner is upside down by a smallish amount, say $10,000 to $50,000, depending on his financial perspective, he might try to negotiate a short payoff with his lender. In this scenario, the lender agrees to release the lien, his interest in the property, allowing it to be “conveyed” or sold to a new owner. The lender agrees to accept less than the amount owed on the property to release the lien, thus “short payoff,” However, in return, the former homeowner signs a promissory note for the difference or some of the difference agreeing to “pay off ” this unsecured line of credit according to the terms of the note.
To do a Short Payoff, the mortgage must be current, the borrower must have great credit, and must demonstrate the ability to pay off the debt. The upside of this situation? The former homeowner keeps his great credit and can purchase another home or anything else he desires.
When is a Short Payoff appropriate? A homeowner might request a short payoff when the home has lost value dramatically or even just enough to make it impossible to sell, and he does not have the ability to pay the large amount to get completely out of the property.
Not all lenders will allow for a Short Payoff; however, you will never know if you never ask.
Of course, the advantages of short Pay-offs are the borrower are able to move out of the property and get on with his life, there SHOULD receive no negative feedback on the former homeowner’s credit.
If for some reason down the line, the borrower’s ability to pay changes and cannot pay on the note, the credit ramifications are significantly smaller.
For further clarification of the entire short sale, foreclosure and short payoff differences, I have just posted an E-Book, Should I Short Sale My Home or How To Survive the Worst Real Estate Market in History, available as a free download, on my website. Plus, it appears in Links to the right of this post.