Pros and Cons: Short Sale or Short Payoff?

You’re ready to move out of your home because you can’t make the mortgage payments, and you owe more on the house than what it’s worth. Your options are limited to a short payoff or a short sale. Here’s how to choose between the two and what it will mean for your long-term financial health.

The Short Payoff

The short payoff is a situation where you owe more on your home than what it’s worth, and you intend on paying off the balance of the loan in full after the sale. So, for example, let’s say you own a home worth $200,000 but you owe $225,000 on it.

If the bank agrees to the short payoff, you’ll have to pay off the difference between the sales price and the remainder of the mortgage. Let’s assume you can sell the property for $200,000. That leaves $25,000 left on the debt.

Now, what the lender will do is make you sign a second promissory note in the amount of $25,000. This is essentially an unsecured loan, like a personal loan. For this transaction to make sense to the bank, you have to have very good credit. But, if you have good credit, why are you in this position in the first place?

These loans are usually only approved in situations where you’re drained of all of your assets and savings, but you still have a strong cash flow – enough to support a smaller loan payment. You also have good credit because you haven’t missed a payment and you pay all of your debts on time.

But, you’re in the danger zone. You could very easily be put into a situation where you start missing payments. Once that happens, the bank is in danger of losing money. This is when a short payoff is beneficial to both the bank and to you.

The Short Sale

The short sale is similar to a short payoff, with one major difference. Instead of paying off the deficiency amount, you let the debt go, and the bank writes it off as “bad debt.”

So, using the previous example, if you have $25,000 in debt left after selling the home, you would not pay off that amount. The bank would then write this amount off and issue you a 1099. This 1099 is sent to the IRS, and the forgiven loan amount is treated as income.

You then pay income tax on this amount. This is a complex process so, if you can, get help from a qualified real estate agent. There’s a lot that can go wrong. And, since you’re not paying back some of the loan, it’s going to reflect badly on your credit.

You will want to ask about a cooperative short sale – a short sale where the bank gives you a cash incentive to stay in the home and maintain it while it’s being sold. This money can then be used to help you move into another apartment when the sale is complete.

Some banks will even offer a relocation incentive. You’ll need this money since you won’t have any credit after this is done.

Which One Should You Choose?

It might seem like an easy choice, but it really depends on your circumstances. If you haven’t missed a payment yet, and you’re confident that you can maintain smaller monthly loan payments, go for the short payoff. Otherwise, you might be better off with a short sale.

Lisa Anders has consulted with homeowners in financial crisis for some time now. An avid blogger, she provides important information to people via the Internet. Look for her informative posts on real estate and mortgage blogs all throughout the web. For more information on the short sale visit NJ Short Sale Center.