Deed in Lieu of Foreclosure: Meaning and FAQs

What Is a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure is a document that transfers the title of a property from the property owner to their lender in exchange for relief from the mortgage debt.

Choosing a deed in lieu of foreclosure can be less damaging financially than going through a full foreclosure proceeding.

Understanding Deed in Lieu of Foreclosure

A deed in lieu of foreclosure is a potential option taken by a mortgagor, or homeowner, usually as a means of avoiding foreclosure.

In this process, the mortgagor deeds the collateral property, which is typically the home, back to the lender serving as the mortgagee in exchange for the release of all obligations under the mortgage. Both sides must enter into the agreement voluntarily and in good faith. The document is signed by the homeowner, notarized by a notary public, and recorded in public records.

This is a drastic step, usually taken only as a last resort when the property owner has exhausted all other options (such as a loan modification or a short sale) and has accepted the fact that they will lose their home.

Although the homeowner will have to relinquish their property and relocate, they will be relieved of the burden of the loan. This process is usually done with less public visibility than a foreclosure, so it may allow the property owner to minimize their embarrassment and keep their situation more private.

Deed in Lieu vs. Foreclosure

Deed in lieu and foreclosure sound similar but are not identical. In a foreclosure, the lender takes back the property after the homeowner fails to make payments. Foreclosure laws can vary from state to state, and there are two ways foreclosure can take place:

• Judicial foreclosure, in which the lender files a lawsuit to reclaim the property
• Nonjudicial foreclosure, in which the lender can foreclose without going through the court system

The biggest differences between a deed in lieu and a foreclosure involve credit score impacts and your financial responsibility after the property has been reclaimed by the lender. In terms of credit reporting and credit scores, having a foreclosure on your credit history can be more damaging than a deed in lieu of foreclosure. Foreclosures and other negative information can stay on your credit reports for up to seven years.

When you release the deed on a home back to the lender through a deed in lieu, the lender generally releases you from all further financial obligations. That means you don't have to make any more mortgage payments or pay off the remaining loan balance. With a foreclosure, the lender could take additional steps to recover money that you still owe toward the home or legal fees.

Advantages and Disadvantages of a Deed in Lieu of Foreclosure

A deed in lieu of foreclosure has advantages for both a borrower and a lender. For both parties, the most attractive benefit is usually the avoidance of long, time-consuming, and costly foreclosure proceedings.

In addition, the borrower can often avoid some public notoriety, depending on how this process is handled in their area. Because both sides reach a mutually agreeable understanding that includes specific terms as to when and how the property owner will vacate the property, the borrower also avoids the possibility of having officials show up at the door to evict them, which can happen with a foreclosure.

In some cases, the property owner may even be able to reach an agreement with the lender that allows them to lease the property back from the lender for a certain period of time. The lender often saves money by avoiding the expenses they would incur in a situation involving extended foreclosure proceedings.

In evaluating the potential benefits of agreeing to this arrangement, the lender needs to assess certain risks that may accompany this type of transaction. These potential risks include, among other things, the possibility that the property is not worth more than the remaining balance on the mortgage and that junior creditors might hold liens on the property.

The big downside with a deed in lieu of foreclosure is that will damage your credit. This means higher borrowing costs and more difficulty getting another mortgage in the future. You can dispute a foreclosure on your credit report with the credit bureaus, but this doesn't guarantee that it will be removed.

Reasons Lenders Accept or Reject a Deed in Lieu of Foreclosure Agreement

Whether a lender decides to accept a deed in lieu or reject can depend on several things, including:

• How delinquent you are on payments
• What's owed on the mortgage
• The property's estimated value
• Overall market conditions

A lender may agree to a deed in lieu if there's a strong likelihood that they'll be able to sell the home relatively quickly for a decent profit. Even if the lender has to invest a little money to get the home ready for sale, that could be outweighed by what they're able to sell it for in a hot market.

A deed in lieu may also be attractive to a lender that doesn't want to waste time or money on the legalities of a foreclosure proceeding. If you and the lender can come to an agreement, that could save the lender money on court fees and other costs.

On the other hand, it's possible that a lender might reject a deed in lieu of foreclosure if taking the home back isn't in their best interests. For example, if there are existing liens on the property for unpaid taxes or other debts or the home requires extensive repairs, the lender might see little return on investment by taking the property back. Likewise, a lender may be put off by a home that's drastically declined in value relative to what's owed on the mortgage.

Other Ways to Avoid Foreclosure

If you're facing foreclosure and want to avoid getting in trouble with your mortgage company, there are other options you might consider. They include a loan modification or a short sale.

Loan Modification

With a loan modification, you're essentially reworking the terms of an existing home loan so that it's easier for you to repay. For instance, the lender may agree to adjust your interest rate, loan term, or monthly payments, all of which could make it possible to get and stay current on your mortgage payments.

You may consider a loan modification if you would like to stay in the home. Keep in mind, however, that lenders are not obligated to agree to a loan modification. And if you're unable to show that you have the income or assets to get your loan current and make the payments going forward, you may not be approved for a loan modification.

Short Sale

If you don't want or need to hold on to the home, then a short sale could be another alternative to a deed in lieu of foreclosure or a foreclosure proceeding. In a short sale, the lender agrees to let you sell the home for less than what's owed on the mortgage.

A short sale could allow you to walk away from the home with less credit score damage than a foreclosure would. But you may still owe any deficiency balance left after the sale, depending on your lender's policies and the laws in your state. It's important to check with the lender beforehand to determine whether you'll be responsible for any remaining loan balance when the house sells.

The Bottom Line

A deed in lieu of foreclosure could be a suitable remedy if you're struggling to make mortgage payments. Before committing to a deed in lieu of foreclosure, it's important to understand how it may impact your credit and your ability to buy another home down the line. Considering other options, including loan modifications, short sales, or even mortgage refinancing, can help you choose the best way to proceed.