What is a deed in lieu of foreclosure?
A deed in lieu of foreclosure is an agreement between a mortgage borrower and the lender where the borrower transfers ownership of the property to the lender in exchange for the lender releasing the borrower from her or his mortgage obligation. Instead of the lender foreclosing on your property to cure a mortgage default, you agree to give them the property to resolve the situation. In simpler terms, the lender receives your property and your mortgage goes away.
Please note that a deed in lieu of foreclosure is different than a short sale. Although both transactions require lender approval, after a short sale, a third party owns the property. In contrast, after a deed in lieu of foreclosure, the lender owns the property.
A deed in lieu of foreclosure usually occurs when borrowers are struggling to pay their mortgage, have defaulted on their loan and the property value is more than the outstanding mortgage balance. In this scenario, a deed in lieu of foreclosure offers several advantages to both the borrower.
For borrowers, a deed in lieu of foreclosure avoids an actual foreclosure, is less damaging to your credit profile and typically enables you to resolve a mortgage default more quickly. In short, you can move on from the mortgage and move forward with your life sooner without going through the potentially painful foreclosure process.
For lenders, a deed in lieu of foreclosure typically costs less, takes less time and is less contentious because both parties must agree to the deed in lieu as compared to a foreclosure process which may be protracted and involve judicial proceedings. The downside to a deed in lieu of foreclosure is that the lender owns the property when the transaction is completed -- at least for a certain period of time -- and most lenders are not in the business of owning real estate.
In reality most lenders really do not want to enter into a deed in lieu of foreclosure, short sale or an actual foreclosure so there are several alternatives you should explore before you reach that point. First, if your property is worth more than your outstanding loan balance, you can sell the property and pay off your mortgage without involving the lender, which is an ideal scenario.
Your second option is to refinance your current mortgage with a more affordable and sustainable mortgage. There are multiple refinance options for distressed homeowners who have fallen behind on their mortgage. Some of the more popular programs include:
Enhanced Relief Refinance Program. The program does not apply a maximum loan-to-value (LTV) ratio which makes it applicable for borrowers who are underwater on their mortgage. The program uses more flexible qualification requirements.
High LTV Refinance Option. The program does not use a maximum LTV ratio, minimum credit score or maximum debt-to-income ratio for most borrowers which enables more distressed borrowers to refinance their mortgage.
FHFA Principal Reduction Modification Program. The program is designed to help eligible, delinquent borrowers become current on their mortgage, reduce their mortgage payment and avoid foreclosure.
Other Distressed Refinance Programs. Review a number of other refinance programs for borrowers who are behind on their mortgage.
The programs outlined above are offered by traditional lenders such as banks and mortgage brokers. We recommend that you contact multiple lenders in the table below to determine program availability and to find the best mortgage terms.
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Your lender must participate in these programs for you to be eligible. We recommend that you contact your lender to determine the refinance, principal reduction or loan modification programs you may be eligible for. Additionally, you may also want to contact HUD's Making Home Affordable Program to learn more about the programs it offers for distressed homeowners.
If you are unable to sell your home or refinance your mortgage with one of the programs outlined above, there are several points to keep in mind if you decide to move forward with a deed in lieu of foreclosure. It is important to emphasize that a deed in lieu of foreclosure must be entered into willingly by both the borrower and the lender and you cannot force either party to participate. An agreement is usually struck through negotiations between the property owner and the lender.
This compares to a foreclosure where the lender, working through the judicial system, can seize a borrower’s property without her or his consent (if the borrower has defaulted on the mortgage). In other words, homeowners do not agree to a foreclosure, it happens to them, whereas they are willing participants to a deed in lieu transaction.
Because a deed in lieu of foreclosure is a voluntary agreement between the lender and the borrower, lenders are more willing to enter into an agreement if the property value exceeds the outstanding loan balance. In this scenario, the lender takes ownership of the property through the deed in lieu of foreclosure and then typically attempts to sell the property as fast as possible to recover its outstanding mortgage balance. If your property value is less than the outstanding mortgage balance the lender may still be willing to agree to a deed in lieu, because they may foreclose on the property anyway, although this is less likely.
If you have fallen behind on your mortgage and think a deed in lieu of foreclosure may be a financially responsible option, your first step is to contact your lender in writing and assess its interest level. It can be helpful to understand your estimated property value by talking to a real estate agent or reviewing property valuation websites.
If your property value is worth more than your loan balance a lender may be willing to start negotiations. If your property value is worth less than your loan balance your lender may be less amenable to a deed in lieu of foreclosure but open to a short sale or other alternative.
Please note that the tax code does not allow forgiveness of debt (unless the property is located in a non-recourse state) and may treat any negative difference between your current loan balance and the mortgage payoff received by the lender as ordinary income, which is taxable. In short, if you payoff your mortgage for less than the full amount you owe, you may owe taxes on the difference. We recommend that you check with your accountant or an attorney in your state to understand the potential tax consequences of a deed in lieu of foreclosure or a short sale.
Our best advice is to gather information about your current property value and have a conversation with your lender about your late payment issue as well as any refinance options that may be available.
Sources
“What is a deed-in-lieu of foreclosure?” CFPB. Consumer Financial Protection Bureau, September 25 2017. Web.
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