Options When Equity in Your Home Is Gone

April 23, 1999 I have been transferred and need to sell my home. The market has gone down and I owe more than the home is worth. Is there any relief available to allow me to avoid paying the difference to the lender at the time of sale? No. Had your house appreciated in value, the lender would not have shared in the benefit, so there is no reason why the lender should take a hit if the value declines. Yet the fact is that in many cases where the borrower's equity is wiped out, the lender does take a hit simply because the borrower is unable to pay. In such cases, lenders will often accept a "deed in lieu of foreclosure", which they view as preferable to foreclosure because it avoids litigation expenses. A deed in lieu of foreclosure is a kind of friendly foreclosure in which the lender agrees not to pursue you for the balance of what is owed. It will hurt your credit rating, but not as badly as a foreclosure. Lenders accept a deed in lieu of foreclosure when they believe the only alternative is foreclosure. If they know the borrower is well-heeled, they will want to be paid in full. Sometimes partial payments are negotiated.  "Your column on borrowers who can no longer pay and who have properties worth less than the mortgage fails to mention another option�the short sale, which allows the borrower to sell the property with the lender's approval." You are right. With a deed in lieu of foreclosure (DIL), the borrower surrenders title to the lender, who sells it, whereas with a short sale, the borrower sells the property with the proceeds going to the lender. While a short sale allows the lender to avoid the expense and hassle of maintaining and then marketing the property, the lender permits it only if there is evidence that the alternative is foreclosure or a DIL. From the lender's standpoint, the borrower who owes $100,000 is not relieved of the obligation to repay that amount just because the value of the house securing the loan has fallen to $80,000. Hence, lenders entertain short sale proposals only from borrowers in financial distress -- from unemployment, health problems, job transfer, and the like. The burden is on the borrower to document the distress. If the lender accepts the borrower's petition, the house is sold at a price the lender finds acceptable. The lender then writes off the difference between the sale price net of expenses, and the balance on the loan. Both a short sale and a DIL damage the borrower's credit rating less than a foreclosure because they reflect an attempt by the borrower to come to terms with the lender. But the short sale is less damaging than a DIL because it indicates a recognition by the lender that the event was caused by factors outside of the borrower's control. Note: The Mortgage Professor is indebted to Derek Kirk, who arranges short sales in California, for information on the practice.   Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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