Short Sale, Deed-in-Lieu, and REO - What are they and how are they different?

These terms are thrown around a lot and although we are very familiar with them a lot of people do not know exactly what they mean. I thought I'd take a moment to give a brief description to help sort out some of the confusion.

A little preface - these situations arise from our unfortunate current economic condition where the home we are in is no longer worth what we still owe on the loan or mortgage. This situation is commonly referred to as "upside down". Normally the home is worth more than the borrowed loan amount but with the boom in prices in recent years followed by a sharp decline many people are "upside down". If you suffer a decrease in your income (from a furlough, layoff, etc.) or your mortgage was an adjustable rate mortgage (ARM) and has begun to adjust or increase you may have trouble making the payment. If one can no longer afford to make the mortgage payment a short sale, a deed in lieu, or a foreclosure might be the only way out.

A short sale is a transaction in which the lender, who originally loaned the money for the home purchase, agrees to accept less than the mortgage amount owed by the current homeowner. In most cases the difference is forgiven by the lender and the homeowner walks away with only an impact to their credit. In other cases the homeowner must make arrangements with the lender to settle the remainder of the debt or claim the difference as income on their tax return. A short sale is generally less expensive than a foreclosure for the lender so in most situations where there exists a "hardship" the lender will agree to a short sale. However, if the lender denies the short sale or the home does not attract a buyer we must think about a deed-in-lieu.

If a short sale does not work or is not granted there is the option of "deed in lieu of foreclosure". In this situation the homeowner basically gives the bank the deed in exchange for the promise not to foreclose and possibly the forgiveness of the remaining debt. The lender can accept and forgive the balance of the loan, accept and go after a deficiency judgement for the difference after the home is sold, or deny the deed in lieu of foreclosure request altogether. More often than not the bank prefers to keep the home out of foreclosure so a deed in lieu of is an attractive, very rapid solution.

A foreclosure in simplest of terms is when the bank takes back the home. Most times the bank will sell it again where it will be listed as an REO (Real Estate Owned). I've heard of some banks keeping homes as rentals to produce income and also wait for home values to rise again before selling. What the bank does with the home at that point their decision because they essentially own it. If the homeowner is forced to foreclose it does have more dramatic affects on their credit score which will make it more difficult for them to buy again in the future (car loans, home loan, credit cards, etc).
(There are legal and tax implications involved with these situations so please consult with the appropriate professional.)

It's not the most positive blog post in the world but I hope it might create some understanding. If I can answer any questions please contact me and we can talk at length about your specific circumstances and what would be best for you!