An underwater owner owes more than the home will sell for after costs. They usually think they have one choice. They have several. When I walk through underwater seller options, I compare them on four things: cash needed, credit damage, how long until they can buy again, and who controls the outcome. The name of the option matters less than those four. For the mechanics of a short sale itself, see short sale basics.
The short answer
Three questions narrow it fast. Can they still make the payment? Do they have to move? How much cash could they really bring to closing? If they can pay and don't have to move, waiting is often the cheapest choice. If they must move and have cash, selling and bringing the difference is the cleanest exit. If they can't pay and have no cash, it usually comes down to a short sale or a deed in lieu, with foreclosure as the outcome nobody picks on purpose.
Step by step
- Get the real gap. Payoff on every loan against the home, minus a realistic sale price and selling costs. Run a pricing report. See how to price a listing.
- Ask the three questions. Payment, move deadline, cash. Write the answers down.
- Walk the six paths.
- Stay and wait. No credit damage. Extra principal shrinks the gap. Ask if the payment still works if income drops.
- Rent it out. Only if rent covers the payment, taxes, insurance, repairs and vacancy with room to spare. Check the loan's occupancy rules and the HOA's lease rules.
- Sell and bring the difference. No lender approval and no credit hit. They pick the date.
- Short sale. The lender accepts less than the payoff. Needs approval, takes time, and they see the terms before they sign.
- Deed in lieu. They hand the home back. The lender must agree, and a second loan on title often blocks it.
- Foreclosure. The lender controls the timeline and the result.
- Send deficiency questions to an attorney. The deficiency is the unpaid balance after the sale. Releasing the lien is not the same as releasing the borrower. In Colorado, a lender can have years to sue for a deficiency. In a short sale, the waiver has to be negotiated and written in the approval. Every lien, including a second loan or HELOC, needs its own written answer.
- Send tax questions to a CPA. Forgiven debt is often reported on a Form 1099-C. Whether it's taxable depends on the rules for that year and on exceptions like insolvency. See IRS Topic 431 and IRS Publication 4681.
- Talk about buying again. Waiting periods depend on the loan type and the event. Fannie Mae publishes its rules in the Selling Guide. FHA and VA have their own. A lender confirms.
A comparison table (illustration only)
| Path | Cash needed | Credit effect | Wait to buy again (conventional, typical) | Who controls it |
|---|---|---|---|---|
| Stay and wait | None extra | None | No wait | Owner |
| Sell, bring cash | The gap | None | No wait | Owner |
| Short sale | Usually none | Serious | Often 4 years, shorter with documented hardship | Shared, lender approves |
| Deed in lieu | Usually none | Serious | Often 4 years | Lender agrees |
| Foreclosure | None | Most serious | Often 7 years | Lender |
Illustration only. Waiting periods and credit effects vary by loan program, lender overlays and the borrower's file. A lender sets the real terms. The annual percentage rate (APR) on any future loan would differ from a note rate. This is not an offer of credit. Program rules change. Check current waiting periods in the Fannie Mae Selling Guide and ask a licensed loan officer.
How to explain it to your client
"Being underwater doesn't force anything by itself. Missing payments does. So let's look at your real numbers and line up every path: waiting, renting, selling and bringing cash, a short sale, or handing it back. For each one, I'll show you the cash it takes, what it does to your credit, how soon you could buy again, and who's in control. Anything about owing money later goes to an attorney, and anything about taxes goes to a CPA. I'll give you the questions to ask."
Watch-outs
- Doing nothing scores worst. It pushes the owner toward the two options they'd least choose.
- "Walking away" isn't easy. It often means foreclosure, the longest credit hit and no say in the deficiency.
- Read the approval letter. Look for language that releases the borrower, not just the lien. An attorney should review it.
- Seconds and HELOCs have leverage. They know the sale can't close without them.
- Rental math must be honest. Use real rents, real repairs and some vacancy.
- Don't quote tax outcomes. Two owners with the same 1099-C can owe very different amounts.
- Don't promise approval. Lenders decide short sales and deeds in lieu.
Further reading
- Short Sale, Foreclosure, or Stay? Compare Your Options on kennarealestate.com
- Can the Bank Come After You After a Short Sale in Colorado? on kennarealestate.com
This is training for real estate agents. It isn't legal, tax or lending advice. A licensed loan officer sets loan terms. Talk to an attorney or CPA. Check with your managing broker.
Questions
Which option hurts credit least?
Selling and bringing the difference does no credit damage. After that, a short sale is usually lighter than a foreclosure.
Is a deficiency waived automatically in a short sale?
No. It has to be negotiated and written into the approval. Have an attorney read it.
Is forgiven debt taxable?
It can be. It depends on that year's rules and exceptions like insolvency. A CPA decides.
When can they buy again after a short sale?
It depends on the loan type and their file. Conventional loans often require about four years, sometimes less with documented hardship. A lender confirms.
Can they switch paths partway?
Often, yes. Earlier is better. Once a sale date is set, choices shrink.
Brian Lee Burke is the founder of PadLeaders, a Colorado real estate broker licensed since 2003, team leader of The Kenna Group at Keller Williams DTC (formerly Kenna Real Estate Group) and the author of Mastering Real Estate and The Real Estate Playbook. More about Brian.