Selling an Underwater Home Without Doing a Short Sale

Alternative Ways to Sell a Home with Negative Equity

Woman hanging For Sale sign on porch
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A short sale is a contract with a lender to sell a home for less than the amount still owed on the home loan. A lender might agree to a short sale under certain conditions, including financial issues forcing the owner of the home to sell, a weak housing market keeping the market value of the home below the amount owed, and a small enough difference between market value and amount owed that taking the home through a foreclosure process would cost the lender more money than just letting a short sale take place.

Not all home sellers qualify for a short sale, and not all homes are strong candidates for one.

Laws that have to do with short sales vary by state. For instance, some states require lenders to forgive any leftover balance after a short sale, while others allow lenders to still collect that money. People who are thinking about a short sale should get to know their own state's laws and seek legal and financial counsel to find out if a short sale is the best course of action for them.

A Real-World Example

Anna bought a home in Fresno in 2005 and put down more than $100,000 in cash. She made a few minor upgrades to the home and gave the kitchen a facelift. Due to a declining market and climbing interest rates, she can't sell her home for the amount she owes. Even so, she might not qualify for a short sale.

First, she has no financial hardship. She just has a home with negative equity. Second, short sales affect credit, and Anna doesn't want her credit to get dinged or her FICO scores to fall. Third, she wants to buy another home. She feels her neighborhood has gone downhill over the years and she no longer feels safe there. One option might be a strategic short sale.

Strategic Short Sales

A strategic short sale is a short sale without a hardship. It's planned, calculated, and approved by a short sale bank. It can be in exchange for a big cash incentive paid to the bank by the seller, but that is rare to see. Still, a strategic short sale still might be a way to sell an underwater home like Anna's.

If she rents out her home, she would receive about $1,500 a month. This is much less than her mortgage payment, taxes, and insurance that adds up to $2,200 per month. Not counting vacancy factors, maintenance, or repairs, Anna would pay $700 a month to support her home as a rental. Over 10 years, that's $84,000. So, if Anna offers an amount less than $84,000 to the bank to release her from her loan and the bank accepts that offer, Anna could be ahead of the game. 

Deed-in-Lieu of Foreclosure

Another option for Anna is to transfer the title to the home to the lender through a deed-in-lieu of foreclosure. In this case, the owner agrees to give up the home to the lender prior to a foreclosure proceeding, and the lender forgives the balance that remains on the home loan.

This gets homeowners out of a stressful situation more quickly, and lenders can avoid the cost and time it takes to foreclose on a home and evict anyone living there. 

Exchange of Security

Anna and owners in similar situations can also look at an exchange of security. This means using the equity in a second property to make up the difference on the first home.

This works only if an owner owns other property free and clear. The bank might agree to swap the security for the mortgage from the underwater home to the home without a mortgage. By switching out the security for the loan, the owner might be able to sell the underwater home at a decent price without a loan in place. The homeowner then can use the proceeds from that sale to pay down as much of the home loan as possible. This could be a good option if the debt that remains is less than the value of the property that previously was owned outright.

Key Takeaways

  • If you owe more on your mortgage than your home is currently worth, it is said to be underwater.
  • In many cases, a short sale to a bank will get an underwater homeowner out of their predicament.
  • A deed in lieu of foreclosure is another option where you remain in your home but transfer title to the bank.