While we all want to think of our homes as sound investments, the changing real estate climate sometimes works to bring a home’s value down. If your home loan is now substantially higher than the value of your home, you may wish to refinance or negotiate a short payoff. If you can’t qualify for either of those financing solutions, you may need to short-sell your home to avoid foreclosure.
A short payoff, like a short sale, is a process by which the lender agrees to accept less than the amount of the principal value owed on a home loan. But there are some important differences between the two options. A third option – refinancing – might be preferable, depending on your financial position.
What is a Short Payoff?
A short payoff allows you to sell your home for less than you owe the bank. Not everyone can qualify for a short payoff because it requires very good credit. If you can stay in your home for awhile, you might find it easier to refinance with a lower interest rate or a longer term for repayment. For those who must sell and whose property values have fallen, short payoffs are an increasingly common solution. Freddie Mac reports that their volume of short payoffs grew more than 1,000 percent from 2007 through 2009.
If you need to move and the selling price of your home won’t pay your full balance due, you can approach the bank to negotiate a compromise. In a short payoff, your credit won’t suffer because you’ll end up paying what’s owed on the home even after it’s sold.
Here is how a short payoff on an existing home loan works:
- Your lender will settle the loan for less than the current amount owed and release the lien on your property.
- The lender doesn’t just forgive the difference; you’ll be required to sign an unsecured loan for some or all of the difference owed.
- Since the lender eventually gets most or all of what was owed, a short payoff option will not harm your credit rating.
- Because you retain your good credit, you can qualify to purchase another home right away.
Freddie Mac warns against fraudulent short-payoff opportunities. They caution consumers to read the fine print when doing short-payoff paperwork. Additional tips can be found at
Are You a Good Candidate for a Short Payoff?
A short payoff option is not for everyone. A good candidate for a short payoff must have:
- The ability to pay off the remaining debt
- Current mortgage payments up-to-date
- Excellent credit
A short payoff is appropriate when your home has depreciated enough to make it impossible to sell and you don’t have the cash in hand to pay off the difference. You’ll probably have to show the bank that you’ve experienced some financial hardship. While some lenders won’t accept a short payoff, many will. Home values have dropped nationwide in recent years, so more and more lenders are trying to accommodate homeowners with financial hardship.
Understanding Short Sales
Short sales are another option when your mortgage is substantially higher than the value of your home, you are having trouble making your payments and you want to avoid foreclosure. In a short sale, like in a short payoff, the lender releases the lien in exchange for a payment that’s less than the principal balance owed to settle the loan. The Fair Isaacs Corporation, or FICO®, will see this option as a default on your loan and your credit score will drop accordingly.
- With a short sale, after the loan is paid off and the home is sold, the transaction is complete. The original homeowner does not owe the lender anything more.
- The price for forgiving part of your debt is that your credit rating will suffer. Expect your FICO® score to drop by at least a hundred points after a short sale.
- Because it will take time to repair your credit score, you will not qualify for a mortgage for the next few years and will have to rent during this time period.
If you are facing a hardship situation and can’t make the payments for a mortgage with an amount much higher than the current value of your home, you may be a good candidate for a short sale. If you don’t want your credit rating to suffer and can’t commit to paying off the balance owed in a short payoff, you may wish to refinance instead.
FHA Short Refinance Program
When homeowners are underwater on a non-FHA mortgage, they have another option through the Federal Housing Administration (FHA). Since September of 2010, the FHA has offered a refinance program that allows homeowners to get a new loan. Here’s their explanation of how a homeowner can qualify:
- “The homeowner must owe more on their mortgage than their home is worth and be current on their existing mortgage.”
- “The homeowner must qualify for the new loan under standard FHA underwriting requirements and have a credit score equal to or greater than 500.”
- “The property must be the homeowner’s primary residence.”
- “The borrower’s existing first lien holder must agree to write off at least 10% of their unpaid principal balance, bringing that borrower’s combined loan-to-value ratio to no greater than 115%.”
A few additional restrictions apply, so check with your lender if you think an FHA-insured refinance loan is for you.