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Sometimes, life happens and leaves you to pick up the pieces. When it does, you may find yourself facing a disastrous domino effect, like when losing your job becomes losing your home.
But instead of bracing for the emotional and financial distress that accompany foreclosure proceedings, sometimes it’s better to walk away.
If that sounds like a more favorable alternative, you might consider a deed in lieu of foreclosure agreement.
What Is Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure, or simply deed in lieu, is a legal agreement between a property owner and their mortgage lenderto circumvent foreclosure.
During a deed in lieu, you voluntarily relinquish the title of your home to the lender in return for absolution of your mortgage debt.
It’s common to see these arrangements when borrowers end up underwater on their mortgage (when they owe more on their loan than the property is worth).
A deed in lieu lets homeowners satisfy their obligations while avoiding the repercussions of foreclosure.
Still, you don’t come out completely unscathed – just better off. As such, deed in lieu proceedings are usually the last resort for homeowners who’ve exhausted other alternatives.
What Happens When You Do a Deed in Lieu of Foreclosure?
When you go through a deed in lieu, the lender releases you from your mortgage obligation in return for your home’s title. Then, the lender may sell the property (or have you attempt to sell it) to recoup their losses.
While the homeowner gives up their claim to the property during these proceedings, they’ll no longer be bogged down by the burden of a loan they can’t pay.
And, although a deed in lieu comes with substantial consequences, it’s often less public and expensive than foreclosure.
How Will a Deed in Lieu Affect Me?
Since a deed in lieu is technically a loan default, it can affect your life in several ways.
Perhaps the most apparent outcome of a deed in lieu is losing the title of your home. For some lenders, that means sending you packing immediately. But others may work with you for a smoother transition.
For example, you may get a “cash for keys” offer that offsets your moving costs in return for forfeiting your deed without damaging your home. Or you may be allowed to rent your home at a fair market price for up to a year.
When you do a deed in lieu, the lender usually sells your property. But if they take a loss, they may waive the debt deficiency instead of suing for the balance. While this lets you off the hook, you may owe income taxes on the forgiven debt.
However, you may be exempt if you:
- Qualify for the Qualified Principal Residence Indebtedness or other exclusions
- Have your debt discharged in bankruptcy
- Are insolvent when the lender forgives your debt
Once your deed in lieu goes through, it appears on your credit report for seven years. But unlike a traditional foreclosure, you can often get another mortgage within 2-3 years.
However, that may not be easy if a deed in lieu tanks your credit score. While the impact is usually less severe than foreclosure, FICO notes that your score may drop up to 125 points if you have excellent credit. But with good to okay credit, your score may drop as little as 50 points.
Steps in the Deed in Lieu of Foreclosure Process
A deed in lieu doesn’t happen overnight – but it can go by quickly if you’re prepared for these four steps:
- Contact your mortgage company and request a deed in lieu of foreclosure – the earlier, the better!
- Gather all your financial documents, including your mortgage and bank statements, pay stubs, and other bills.
- Fill out your lender’s deed in lieu of foreclosure form and provide any requested information. Don’t forget to ask the lender to waive their right to collect deficiencies!
- Work with your lender to fulfill their requirements, which may include putting the house on the market for up to three months, vacating quickly, or signing legal documents.
Additionally, you may hire a real estate attorney to help you understand your rights, navigate legal documents, and negotiate lower fees.
Other Ways to Avoid Foreclosure
If you’re looking for alternatives to a deed in lieu, you do have two other options.
Modify Your Loan
A loan modification serves homeowners who want to keep their property but can’t afford their average mortgage payments.
While a lender has no obligation to modify your loan, they may take steps to avoid foreclosure, like:
- Lowering your interest rates or monthly payment
- Forgiving some of your balance
- Extending your loan term
Your lender may also agree to forbearance, wherein some of your principal is temporarily held in a non-interest accruing account.
If you want to avoid both a deed in lieu and foreclosure, you might try a short sale. This occurs when your lender agrees to let you sell your home for less than your mortgage balance.
While you handle the buyers and real estate agents, the lender helps execute the sale and may even front closing costs.
However, short sales carry a risk of owing a deficiency balance in some states. You may also see your credit score drop substantially and have to wait 2-7 years to qualify for another mortgage.
But on the bright side, you can often get an FHA mortgage immediately after a short sale, presuming you meet the credit, income, and payment history requirements.
What Is Better: a Short Sale or Deed in Lieu of Foreclosure?
Typically, a deed in lieu is better for homeowners, as they can have less impact on your credit and come with a shorter waiting period to get a new mortgage. That said, banks may be more willing to approve a short sale.
Deed In Lieu vs. Foreclosure: What’s the Difference?
During a deed in lieu, you voluntarily relinquish your claim on your property in exchange for absolution of your obligations.
You may also have any debt deficiencies forgiven and even receive financial assistance to help you move.
But during foreclosure, a lender goes through various legal channels to obtain your property.
This process may come with court appearances, legal fees, and the possibility of eviction. You may also be sued for any remaining loan balance or legal fees incurred by the lender.
Additionally, if a foreclosure hits your credit report, you can expect your score to plummet overnight – and you won’t be able to take out a new mortgage for up to seven years.
What Are the Advantages of Deed in Lieu of Foreclosure?
A deed in lieu agreement can benefit homeowners in several ways, including:
- Reducing or eliminating your loan deficiency
- Less damage to your credit score compared to a foreclosure
- Being able to take out a new mortgage sooner
- Less publicity
What Are the Disadvantages of Deed in Lieu of Foreclosure?
But as you might imagine, a deed in lieu comes with notable disadvantages, such as:
- Losing your property and any existing equity
- The possibility of deficiency judgments
- Owing state or federal taxes on the forgiven loan balance
- A substantial hit to your credit score
- An inability to take out another mortgage for 2-4 years minimum
Does a Lender Have to Accept a Deed in Lieu of Foreclosure?
Unfortunately, no, your lender doesn’t have to accept a deed in lieu. While it can be more advantageous, especially if both parties want to avoid foreclosure or your home is likely to fetch a decent profit, they may reject your proposal if:
- Your home has depreciated in value
- You have multiple loans or tax liens on your home
- Your home is in poor condition
- Your government-backed home loan only gives a payout if they go through foreclosure
Additionally, your online mortgage lender will consider other factors, such as how delinquent you are and whether you’ve attempted to work out alternatives before it’s too late.
Bottom Line: Deed in Lieu of Foreclosure
A deed in lieu agreement can help you avoid foreclosure while exiting your mortgage obligation.
While such proceedings can get you out of a bind, it can come with serious drawbacks, including tax, credit, and financial consequences.