California Deed in Lieu vs. California Short Sale
How do the workout options effect your liability for the loan balance, taxes and credit
We are seeing a lot of people on the net saying a short sale is always preferable to a deed in lieu.  We wonder if they have actually negotiated deed in lieu of foreclosure or even thought about the tax consequences in the state of California.

Short Sales and Deeds in Lieu of Foreclosure and Foreclosures may affect your credit, your liability for the loan balances and your state and federal tax liability in different ways.

We suggest you look at each option and determine your exposure to deficiency for the loan balance.  Then determine your tax liability to state of CA and the IRS, and then assess the damage you selected option may do to your credit.

Credit

Fair Issac and Company FICO seems to have purposely designed the credit scoring to be hazy.  With respect to the major workout options, the consensus seems to be that computer scoring works like this:

Short Sale, Deed in Lieu and Foreclosure, do about the same amount of damage to your credit line but some people seem to rebuild faster after a short sale.

Many sources claim a short sale hurts your computer credit score and or your ability to qualify for loan programs  for 2-4 years, a deed in lieu of foreclosure for 5 – 7 years and a foreclosure for seven to ten years.

However,

We must note that on your credit history a short sale or deed in lieu, does look more responsible.
(if your property is in San Diego, Orange or Riverside counties you may wish to discuss short sale strategies designed to prevent banks from reporting 30, 60, or 90 day lates.)


Taxes
As of January 2010 it seems  California’s tax code is more or less aligned with the IRS’s tax code on the subject of the mortgage debt forgiveness.
Additionally a deed in lieu gives the borrower a chance to negotiate the fair market value of the property.  (this may substantially alter tax liability).

Deficiency
In California there is a presumption that a deed in lieu of foreclosure will release the seller from financial liability for the underlying notes or loans.
Note:  there are wrinkles that some lenders like to include in their deed in lieu documents.  Be on your guard for lenders who are reserving the right to foreclose to clean up title.
California short sales are becoming more difficult.
Many seconds lien holders and some first lien holders are unwilling to release the sellers from a deficiency.

Sometimes the lenders just need to have the law explained to them.
-There are many  strategies open to sellers while they are still current.
-Do not stop paying your loans until you have set up your walk away plan or workout strategy.
-There is no reason to assume a short sale is going to work…. particularly because most Realtors have a very poor track record.
-If someone is telling you a short sale will save you, make them put it in writing.
-Remember a Realtor is not licensed to explain what the escrow instructions mean to you or whether your are released from a deficiency.
-If someone tells you to tells you to sign the paperwork – ask him to guarantee your release from a deficiency in writing. 

 

(Note…this article was written around 10 years ago.  It will be updated as we have more experience with Mortgage Crisis 2.0.  )