What Is a Deed In Lieu of Foreclosure?

What Is a Deed In Lieu of Foreclosure?

A deed in lieu of foreclosure is an arrangement in which you negotiate with your lender to agree on terms for turning over your house and vacating the property. In exchange, the lender closes out your mortgage loan. A deed in lieu can spare both you and the lender the legal costs of a foreclosure proceeding.

Your credit will still take a hit, however, because your mortgage will be listed as closed but not paid as agreed in a deed in lieu of foreclosure arrangement. You also could still end up owing the lender money, and you could be liable for income tax on any portion of your debt that's forgiven. Due to these complexities, it's often wise to seek legal and financial advice if you decide to pursue a deed in lieu.

Learn more: How Can I Stop Foreclosure?

How Does a Deed in Lieu of Foreclosure Work?

A deed in lieu of foreclosure works by transferring ownership of your home to your lender if you're unable to make your payments. In exchange for your cooperation and leaving the house in good condition, your lender may consent to:

• Let you stay in the house for an agreed-upon length of time while you find other living arrangements.
• Provide a cash-for-keys stipend when you vacate the house—a payment you can put toward moving expenses and/or funding for a new place to live.
• Release you from some or all responsibility for deficiency on the mortgage—any amount by which the balance on the mortgage exceeds the home's appraised value.

Tip: Lenders are not obligated to grant requests for deeds in lieu of foreclosure, and can decline them for a variety of reasons.

Reasons a Lender May Reject a Deed in Lieu of Foreclosure

A deed in lieu of a foreclosure is an arrangement that may reduce financial losses for both the borrower and the lender, but the lender won't always agree to one. Instead, they'll consider the specifics of your situation to assess whether to accept a deed in lieu.

Here's a breakdown of reasons your lender may reject your request for a deed in lieu.

• There are liens or judgments on the home. Other claims on the property complicate your ability to pursue a deed in lieu agreement because the other parties may not be willing to release their claim. When possible, resolving liens on the home before you pursue a deed in lieu may be your best option.
• The home is in poor condition. If the home isn't in good shape, the lender may not feel confident that the home will sell quickly or for market value. In this case, they may pursue foreclosure and sell the house at auction to recoup their losses instead.

Reasons a Lender May Accept a Deed in Lieu of Foreclosure

A lender may accept a deed in lieu of foreclosure if they determine that it's the most financially beneficial option for them. Specifically, common reasons a lender may accept a deed in lieu include:

• You meet the basic qualifications. To qualify for a deed in lieu, your lender will require you to demonstrate financial hardship. You may also need to meet other requirements, such as being in an extended period of delinquency, being unqualified for a loan modification and showing an unsuccessful attempt to sell the home.
• You owe more than the home is worth. While it's not guaranteed, some lenders may accept a deed in lieu if you owe more than fair market value on the property. They may be willing to accept a deed in lieu agreement if they believe they'll recoup more money than they would if they foreclosed on the home.
• The lender wants to avoid litigation. Litigation is a long and costly legal process in which the lender files a lawsuit against the borrower to seize the home. A lender may be willing to accept a deed in lieu if they believe it will be a quicker or more cost-effective way to regain possession of the home.
• The lender wants to preserve the condition of the home. During the long process of foreclosure, a home may sit vacant and lose value due to lack of maintenance and deterioration. If your home's in good condition, the lender may see a deed in lieu as more desirable. They may be able to sell a home that's in good repair in less time—and for more money.

Deed in Lieu vs. Foreclosure

Foreclosure is the legal process by which a mortgage lender exercises its right to seize a house if the borrower(s) who financed the property fail to make required loan payments. Procedures differ by jurisdiction, but foreclosure can be time-consuming (taking years in some states) and expensive for both the lender and the borrower.

On the other hand, a deed in lieu of foreclosure arrangement avoids the legal foreclosure process by allowing the borrower to turn the deed over to the lender voluntarily. Typically, the borrower must vacate the property promptly at an agreed-upon time and leave it in good condition. In exchange for these considerations, the lender may grant the borrower certain courtesies or concessions.

Learn more: How Does a Foreclosure Affect Credit?

Pros and Cons of Deed in Lieu of Foreclosure

Here are the basic advantages and disadvantages of a deed in lieu of foreclosure:

Does a Deed in Lieu of Foreclosure Hurt Your Credit?

Yes, a deed in lieu of foreclosure harms your credit, but less so than a foreclosure would. If you obtain a deed in lieu, your mortgage will be listed on your credit reports as closed with a zero balance, but not paid in full. This is a negative entry that will remain on your credit report for up to seven years.

It will tend to lower your credit scores as long as it exists on your reports, and it will likely discourage mortgage lenders from working with you for several years. (The Federal Home Loan Administration instructs issuers of federally backed mortgages to disqualify applicants with deeds in lieu of foreclosure less than four years old.)

Learn more: What Affects Your Credit Scores?

How to Request a Deed in Lieu of Foreclosure

If you want to pursue a deed in lieu of foreclosure, here are steps to follow.

1. Do Your Homework

A deed in lieu of foreclosure has serious consequences for your living arrangements and your credit, so before you seek one, make sure you understand its implications.

Consider meeting with a housing counselor and/or a foreclosure attorney. They can guide you as you explore all alternatives, help you decide whether it's your best option, and have a backup plan in case the lender declines your request.

2. Ask Your Lender for a Loss Mitigation Packet

This will include forms required to obtain a deed in lieu of foreclosure, plus a list of financial documents you'll need to provide with the application. These may include documents that demonstrate that you're unable to afford your mortgage payments, including:

• Pay stubs
• Tax returns
• Expense receipts

3. Work With an Expert to Negotiate Terms

Fill out the necessary forms and submit them, along with all required supporting documentation. It's highly advisable to have an attorney assist at this stage so they can spell out any conditions you wish to include in the arrangement and make it clear to you what your responsibilities will be if your proposal is accepted.

4. Respond as Needed to Follow-Up Communications

Promptly provide any additional documents the lender requests and address any changes or counterproposals they make in response to your plan.

5. Stick to the Plan

If you reach an agreement on a deed in lieu of foreclosure arrangement, follow all provisions carefully and conscientiously to avoid breaking the contract and forfeiting the deal.

If your lender declines your request for a deed in lieu arrangement, consider other alternatives to foreclosure.

Alternative Ways to Avoid Foreclosure

In lieu of a deed in lieu, the following are other options for avoiding foreclosure:

Short Sale

A short sale typically involves a mortgage that's "upside down"—one with a balance that exceeds the home's market value. This can occur if housing prices fall after a borrower buys at a price peak, if property sustains damage that isn't covered by insurance or if home maintenance is inadequate.

In a short sale, the lender grants permission for the borrower to put the home on the market. Then, the lender accepts the proceeds of the sale and closes the borrower's mortgage. After a short sale, the loan is listed on the borrower's credit reports as not paid as agreed.

Tip: Depending on negotiated terms and local laws, the borrower may be required to cover any portion of their loan not satisfied by the sale.

Mortgage Modification

A mortgage modification addresses a borrower's inability to cover their loan payments by restructuring their original loan to make monthly installments more affordable. This typically entails extending the loan term by several months or years, which adds additional payments to the loan and typically increases the total interest paid over the life of the loan.

Learn more: How Can I Get a Mortgage Modification?

Repayment Plan

If you've missed one or more mortgage installments but are ready and able to resume your regular payment schedule, your lender may agree to put you on a repayment plan to make up the missed payments.

A repayment plan may entail a lump-sum payment that covers the delinquency or an increase to your monthly payments that lasts until you've repaid the amount you missed (plus interest).

Forbearance

A temporary reduction or suspension of mortgage payments, typically for no more than 12 months, forbearance is offered as a courtesy by some mortgage lenders to customers facing short-term financial hardship. Typically limited to borrowers with good credit, forbearance is only offered to those who ask for it and provide solid evidence they'll be able to resume regular mortgage payments within a short time.

Tip: To qualify for forbearance, you'll also need to show that you can cover the cost of payments not made during the temporary forbearance period. After forbearance ends, you'll need to enter a payment plan to catch up on them.

Chapter 13 Bankruptcy

This legal process addresses overwhelming debt by setting up a repayment plan to repay your creditors fully or in part. If your income supports it, Chapter 13 can allow you to catch up on late mortgage payments and maintain house payments while eventually erasing many other forms of consumer debt.

Chapter 13 bankruptcy can have a major, negative impact on your credit; it's even more severely negative for your credit than foreclosure. Chapter 13 remains on your credit report for seven years and causes deep, lasting damage to your credit scores.

Tip: If you're considering bankruptcy, you'll need to meet with a credit counselor first. Not only is this typically required to qualify for bankruptcy, it's also an opportunity to learn more about your options and decide whether you're a good candidate.

The Bottom Line

Seeking a deed in lieu of foreclosure requires accepting the painful reality that the loss of your house and a hit to your credit are inevitable. If you're facing that situation, a deed in lieu could be your best option for cutting legal costs and moving on within a span of a few years. When you're ready to seek another mortgage, check your FICO^® Score^Θ for free from Experian to know where you stand and, if necessary, take steps to build up your credit before you begin shopping for another home.