Deed In Lieu Of Foreclosure, Explained

When you qualify for a mortgage, you and your lender assume you can and will make your monthly payments on time and in full. But because life rarely goes as planned, you may experience an unexpected issue that causes you to fall behind on your mortgage payments, leaving you at serious risk of foreclosure.

Sometimes a deed in lieu of foreclosure, or a deed in lieu, may be a better option than dealing with the financial and legal burden of the foreclosure process.

We’ll explain what a deed in lieu of foreclosure is and how it works. We’ll also explore its advantages and disadvantages and help you decide whether this strategy may be right for you.

What Is A Deed In Lieu Of Foreclosure?

A deed in lieu of foreclosure is a document that voluntarily transfers a property’s title from a homeowner to their mortgage lender in exchange for releasing them from their mortgage obligation. This deed instrument allows homeowners to satisfy a mortgage loan at risk of default – and avoid foreclosure proceedings.

A deed in lieu can benefit the borrower and lender by sparing both parties from an expensive and time-consuming foreclosure process.

What Are The Advantages Of A Deed In Lieu Of Foreclosure?

While other options exist to avoid foreclosure, a deed in lieu may be a solid alternative for several reasons.

Less Negative Impact On Your Credit Score

A deed in lieu of foreclosure will damage your credit score, but it will do less damage than a foreclosure. With a deed in lieu, you may be able to rebuild your credit and apply for a new mortgage sooner.

Avoid Public Notice Of Foreclosure

A public notice of the pending foreclosure sale may be posted on your front door. Some homeowners prefer to hand the property over to the lender rather than deal with the possible embarrassment of publicly disclosing a foreclosure.

Avoid Further Financial Loss

Depending on the laws in your state, the lender may have the right to request the difference between the sale proceeds and a homeowner’s outstanding mortgage balance after the foreclosure sale. If you voluntarily turn the property over with a deed in lieu, the lender may be more willing to waive the remaining debt.

Lender Incentives

Sometimes lenders provide money to help homeowners maintain their property and find a new living arrangement. How much a homeowner receives may depend on their history of late payments and the home equity they’ve accrued.

What Are The Consequences Of A Deed In Lieu Of Foreclosure?

A homeowner facing foreclosure should understand the consequences of a deed in lieu of foreclosure.

Waiting Period Before Buying A New Home

A deed in lieu of foreclosure will do more than damage your credit. A borrower will need to wait four years before they can apply for a conventional loan to buy a new home. The Federal Housing Administration, U.S. Department of Agriculture and Department of Veterans Affairs treat a deed in lieu the same way they treat a foreclosure. The waiting period for a USDA or FHA loan is three years. It’s a two-year waiting period for a VA loan.

Some lenders may have loan options that allow you to get into a home sooner, so research your options and contact your lender for more information.

Loss Of Equity

While a lender may offer cash incentives, they’re not obligated to pay you for any existing equity in your home.

Deficiency Judgments

Although the mortgage lender may waive the difference between the proceeds from the real estate sale and the balance you owe, they’re not obligated to do so. They may pursue a deficiency judgment to make up the difference.

Tax Liability

Under certain circumstances, the debt forgiven by a lender is considered taxable income. Speak with a tax advisor if you’re unsure how to proceed.

What Are The Steps For A Deed In Lieu Of Foreclosure?

If a deed in lieu of foreclosure is a possible solution, you should know what to expect. Here are the steps of the process:

A deed in lieu of foreclosure is a legal process, so working with a real estate attorney may be a good idea. They can explain the terms of the agreement and clarify what you will and won’t be responsible for. Paying a legal fee to have someone guide you and negotiate on your behalf may even save you money in the long run.

Does A Lender Have To Accept A Deed In Lieu Of Foreclosure?

While a lender may benefit from agreeing to a deed in lieu, they aren’t obligated to accept it. A lender may reject a deed in lieu of foreclosure agreement if:

In other cases, the mortgage loan servicer that collects your payments for the lender may not allow a deed in lieu, or the mortgage agreement may prevent it. Make sure you fully understand all your options.

Deed In Lieu Vs. Foreclosure

While you can avoid the formal foreclosure process with a deed in lieu, you won’t escape the negative impact on your credit and your ability to qualify for a mortgage later on. That means you should look at all other options to avoid foreclosure and only use a deed in lieu of foreclosure as a last resort.

Are There Alternatives To A Deed In Lieu Of Foreclosure?

Before considering a deed in lieu, explore two options that will impact your credit and future mortgage prospects less severely: a loan modification and a short sale.

Loan Modification

A loan modification temporarily or permanently adjusts the terms of your mortgage loan to make your monthly payments more manageable.

When facing a temporary hardship, like losing a job or the aftermath of a natural disaster, you may be able to work out a repayment plan with your lender or go into temporary mortgage forbearance, which allows you to pause your mortgage payments for a specific period.

If your issue is long-term or permanent, you may need to discuss specific loan modifications with your lender, such as forgiveness of a portion of your mortgage balance, an interest rate reduction or extending your loan term.

All these options can offer a financial lifeline that helps you get back on your feet and stay in your home.

Short Sale

A short sale may be an option when a loan modification isn’t possible. A short sale occurs when a homeowner works with a lender to execute a managed property sale for less than the balance on the mortgage, and the lender typically covers closing costs.

Compared to a foreclosure, the most significant advantage of a short sale is that it may offer faster recovery in terms of your ability to qualify for a new mortgage.

You can apply for an FHA mortgage immediately after a short sale, provided that you satisfy the FHA’s credit and other loan requirements. However, a short sale will severely damage your credit score, which may limit your home buying options until you can improve your credit.

The Bottom Line

A deed in lieu of foreclosure involves voluntarily signing property over to a lender rather than going through a formal foreclosure process. You’ll avoid the worst-case scenario of a foreclosure’s impact on your credit, but it will significantly damage your credit. A deed in lieu of foreclosure should always be a last resort after you’ve exhausted every other avenue.