Short sale vs foreclosure vs deed in lieu: which is better?

For most California homeowners, a short sale or a deed in lieu beats a foreclosure. Each one ends the loan with the lender's written agreement, and Fannie Mae's Selling Guide lists a shorter wait before you can borrow again. A foreclosure is the lender's sale, on the lender's date. If your home is worth more than you owe, a regular sale beats all three, because the extra money comes to you. Rules change, so confirm every point below with your servicer and an attorney.

You are reading this because the mortgage has become hard to pay. Take a breath. You have more choices than the notice in your mailbox suggests, and the next few minutes will lay them out in plain words.

What are a short sale, a foreclosure and a deed in lieu?

They are three ways a mortgage can end when the owner cannot keep paying it. Each one hands the house to a new owner, and each one settles the loan in a different way.

The same Fannie Mae page that defines a short sale also sets the waiting periods we cover below. You can read it at Fannie Mae's Selling Guide, section B3-5.3-07.

Do I still owe money if the house sells for less than the loan?

On a trustee's sale or an approved short sale of a home with up to four units, California law bars the lender from collecting the shortfall. Several exceptions apply, so check your own loan with an attorney before you rely on it. The shortfall has a name, a deficiency.

Here is what each section says. I read the text on the California Legislative Information site.

• After a trustee's sale. Code of Civil Procedure section 580d says no deficiency is owed or collected, and no deficiency judgment is rendered, on a note secured by a deed of trust when the property was sold under the power of sale. The same section leaves in place any liability of a guarantor, a pledgor or another surety.
• After a short sale. Code of Civil Procedure section 580e covers a dwelling of up to four units. No deficiency is owed when the lender consents to the sale in writing, title moves to the buyer by a recorded deed, and the proceeds go to the lender as agreed. The lender cannot demand extra pay from you in exchange for its consent. A lender can still pursue claims for fraud or waste, and the section does not apply to a borrower that is a corporation, an LLC or a limited partnership.
• After a deed in lieu. The two sections above name a sale by trustee and a sale to a buyer. Neither names a deed in lieu. So the release has to come from the lender's own written agreement. Ask for a line that says the deed settles the whole debt, and have an attorney read it before you sign.
• Purchase loans. Code of Civil Procedure section 580b adds its own protection for a loan used to buy a dwelling of up to four families that the buyer lives in, and for a refinance of that loan to the extent no new money was advanced.

Second loans and home equity lines are separate loans with separate lenders. Ask each lender what it will do, in writing.

Taxes are the other half of this question. The IRS says that when a debt is canceled for less than the amount owed, the canceled amount is generally taxable, and the law lists exceptions. A lender may send Form 1099-C to report it. Read IRS Topic no. 431, then ask a CPA before you close anything.

How does each one affect your credit?

A foreclosure carries the longest wait before you can get a Fannie Mae backed mortgage again. The Selling Guide lists a standard wait of 7 years after a foreclosure, and 4 years after a short sale or a deed in lieu. Both clocks run from the completion date.

The guide shortens those waits when documented extenuating circumstances apply. It lists 3 years after a foreclosure, with added conditions on loan size and use, and 2 years after a short sale or a deed in lieu. The page I read carries an August 2019 update date and the guide changes, so read the current version at the Fannie Mae Selling Guide before you plan around these numbers.

A credit score is a different thing from a waiting period. Scores move by file, and no figure I can source fits every borrower, so I will not guess one. Other loan programs and lenders set their own waits. If you want to buy again, call the lender you would use and ask for their waiting period in writing.

Who controls the timing and the price?

In a foreclosure the lender does. In a short sale and a deed in lieu you share control with the lender.

A trustee's sale happens on a date set in a recorded notice of sale. Under Civil Code section 2924, that notice follows at least three months after the notice of default, with one exception that lets the notice of sale record up to five days early. The sale date then runs on the lender's calendar. For the full order of notices, read how long foreclosure takes in California. For what each notice says and what to do in the first week, read what to do with a notice of default or a notice of trustee sale.

Money moves in a fixed order after the sale. California Civil Code section 2924k pays the trustee's costs first, then the loan that was foreclosed, then junior liens in order of priority. The trustor, the owner, is paid last. That order is the whole mechanism behind keeping equity. The owner gets money only if the sale brings in more than every cost and every lien ahead of the owner, and the sale price is whatever bidders offer that day.

In a short sale, a buyer and you agree on the price, and the servicer reviews it. That review takes time, so start before the sale date. Ask your servicer how long its review runs and whether it will pause the sale date while it reviews. Do not assume it will. If the sale date is close, read when it is too late to stop a foreclosure in California.

When does a regular sale beat all three?

When the home is worth more than you owe plus the cost of selling. In that case you do not need the lender's permission to sell for less than the loan, because you are selling for more.

Look at the arithmetic. These are illustrative numbers, made up to show the shape of it. A home sells for $1,000,000. You owe $700,000 and the costs of selling come to $60,000. The loan and the costs come out at closing, and $240,000 comes to you. Now picture the same home sold at a trustee's sale. Section 2924k pays costs and liens first, and you receive only what is left after them. You also had no say in the price or the day.

Flip the illustrative numbers for the other case. The home is worth $600,000 and you owe $700,000. That home is under water. A regular sale cannot pay off the loan, so a short sale, a deed in lieu or a foreclosure is what is left to compare. Everything in the sections above applies.

Which case are you in? You cannot answer without a value for the home. The Free Equity & Exit Report gives you that, from real sales near you, along with the plan we'd use to sell it.

If you need a fast close, read about cash offers for your home. If you cannot afford repairs, read about selling a house as is. If you want the full path for selling with a notice on the house, read can I sell my house in foreclosure in California.

Which option fits which situation?

Match the option to the number you find. Four cases cover most homeowners.

What should I do this week?

Call three people, then find out what your home is worth. I cannot promise that any option stops a foreclosure, and neither can anyone else who is honest with you.

This is not legal advice. Foreclosure, deficiency, short sale and tax rules depend on your loan, your lender and the facts of your case, and they change. Talk to a real estate or bankruptcy attorney before you sign a short sale approval, a deed in lieu or any agreement with a lender, and talk to a CPA about canceled debt. Statutes and the Fannie Mae Selling Guide are linked above so you can read the current text yourself.