Deed In Lieu Of Foreclosure
If you’ve fallen behind on your mortgage and you don’t see any way of catching up, a deed in lieu of foreclosure might be your best option and a proactive way to handle the situation. While the consequences can be less severe than allowing your home to fall into foreclosure, it’s not a decision to make lightly since a deed in lieu is almost as serious as a foreclosure.
Here’s what you should know about the advantages and disadvantages of a deed in lieu of foreclosure, how to qualify and the alternatives.
What Is a Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure is an arrangement where a mortgage servicer agrees to let the homeowner turn over the deed to the home when the homeowner can no longer afford to pay the mortgage. Instead of waiting for the servicer to foreclose, the homeowner is proactive and contacts their servicer to work out an agreement.
Under the agreement, the borrower will sign the deed to their home over to the servicer and move out. In exchange, the servicer will release the borrower from their mortgage obligations. A deed in lieu may also be called a mortgage release, surrender of possession agreement, voluntary liquidation or voluntary conveyance.
A deed in lieu of foreclosure can also be a way to get out of an unwanted timeshare—not just a primary residence.
Advantages to a Deed in Lieu of Foreclosure
A deed in lieu of foreclosure has several advantages for borrowers whose only alternative is to wait for a lender to foreclose.
- Cut your losses: Being proactive should limit how far behind you fall on payments and help you avoid fees associated with foreclosure. If you’re in a recourse state where a lender can collect the difference between the home’s value and what you owe, limiting how much you owe will also limit any deficiency judgment. In other words, it will be easier for you to get a fresh start, financially speaking, after losing your home.
- Move on sooner: A deed in lieu of foreclosure takes about 90 to 120 business days to complete. A foreclosure can take years in some states.
- Get relocation assistance: Your servicer may offer a relocation assistance payment of up to $2,000 (for Federal Housing Administration (FHA) loans) or $3,000 (for conventional loans) to help you move if you complete all the requirements of the deed-in-lieu agreement. Note: This payment may be taxable.
- Get free temporary housing: You may be able to stay in your home for up to three months without paying rent under some agreements.
- Delay moving: Another option your servicer may provide is to lease the home back for up to a year. To do this, you’ll have to be able to afford fair market rent.
- Wait less time to qualify for another mortgage: Depending on what type of mortgage you have (conventional, FHA, or VA), your waiting period may be shorter to qualify for another mortgage if you do a deed in lieu instead of a regular foreclosure.
- With a conventional mortgage, the waiting period shrinks from seven years to four years, and it can be as short as two years if you’re giving up your home due to extenuating circumstances.
- For an FHA or VA loan, the waiting period is the same with either type of foreclosure. But again, extenuating circumstances can help you qualify sooner: in fewer than three years for an FHA loan, and as little as one year for a VA loan.
Extenuating circumstances are “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant and prolonged reduction in income or a catastrophic increase in financial obligations” for a conventional loan owned by Fannie Mae. The specific circumstances that qualify can vary depending on who owns your loan.
Be prepared to prove your extenuating circumstances with related documents such as a job severance agreement or copies of medical bills. You’ll need them for the deed in lieu process, and you’ll also need them the next time you apply for a home loan.
Disadvantages to a Deed in Lieu of Foreclosure
A deed in lieu of foreclosure is still something to avoid if you can. Consider the disadvantages before you decide it’s worth it.
- Loss of home equity: When you give your home back to the loan servicer, you lose everything you put into your down payment, the principal part of your monthly mortgage payments and the value of any repairs and improvements.
- Harm to credit score: A deed in lieu may hurt your credit score just as much as a short sale or foreclosure, according to a 2011 FICO study. The study also found that the higher your score is to start, the more a deed in lieu of foreclosure will hurt your score, and it may take seven to 10 years before your score fully recovers. That said, any payments you missed leading up to the deed in lieu may have already lowered your score so much that turning over your deed will have a smaller impact.
- Negative credit report item: A deed in lieu, just like a regular foreclosure, will stay on your credit report for up to seven years, according to Equifax—one of the three major credit bureaus.
- Deficiency judgment: The Consumer Financial Protection Bureau (CFPB) recommends that homeowners ask their mortgage servicer to waive any deficiency in writing so you will not be responsible for any shortfall between how much you owe and how much your home is worth. In some states, lenders can get a deficiency judgment that leaves you on the hook for this money.
- Income taxes on forgiven debt: The IRS may classify the forgiven debt as income, and you may owe taxes on it.
- Less time to find a new place: Some servicers may require you to vacate the property and find a new place to live before the deed in lieu can be finalized. The amount of time it takes for a foreclosure to be finalized could give you more time to move.
How to Qualify for a Deed in Lieu of Foreclosure
Utilizing a deed in lieu of foreclosure is not a decision you can make unilaterally—your mortgage servicer must agree to it. Since your servicer will likely be taking a loss on the transaction, it may require you to go through other steps first, such as attempting to sell your home at market value, qualifying for a loan modification and attempting a short sale. Only if these don’t succeed will you qualify for a deed in lieu of foreclosure.
If your loan servicer allows you to proceed, it will order an appraisal to determine the home’s fair market value and to make sure the home is in good condition, inside and out. You’ll have to submit documents describing your hardship and your financial situation. Also, you may have to pay something toward your remaining mortgage balance as a condition of the servicer approving your deed in lieu of foreclosure. This money is called a cash contribution.
Some borrowers take out their anger at being foreclosed on by damaging the property. A servicer who works with a borrower to agree to a deed in lieu may require the property to be in good shape as a condition of the arrangement. That means no damage, trash and personal belongings left behind. It also means leaving appliances, fixtures and floor coverings in place. In addition, you will likely need to maintain homeowners insurance on the property until the transfer is complete.
Note: If you have other liens on your house, such as a home equity loan or line of credit with a different company, you will need that company to agree to a second lien release.
Your servicer will ultimately provide you with release documents to complete. You’ll need to get these documents notarized.
Why a Lender Would Reject a Deed in Lieu of Foreclosure
It’s not always in your loan servicer’s best interest to agree to a deed in lieu of foreclosure. Here are some situations where they might reject your request:
- You haven’t exhausted your other options. If you haven’t tried selling your home or working out a loan modification, you may not be eligible to sign over your deed.
- Your home is in bad shape. It will be harder for the lender to sell the property and recoup what you owe, so they may not be willing to let you take the easier way out.
- The property’s title is not clear. If you have other liens against your home, such as unpaid property taxes, a contractor’s lien, a homeowners/condo association lien or a second mortgage, these will need to be paid off or released.
- Your financial hardship is not long term. Buying a home and taking out a mortgage are long-term commitments. Financial circumstances that could turn around in the short term and allow you to resume making mortgage payments are not grounds for walking away.
The most obvious thing to do when you can’t afford your home anymore is to sell it. But if you’re considering handing your keys over to the bank, then selling probably isn’t an option because you can’t get enough from the sale to repay what you owe.
That doesn’t mean you’re out of options, though. These alternatives to a deed in lieu of foreclosure might place less of a strain on you emotionally and financially.
- Housing counseling. The CFPB can help you find a nonprofit housing counselor approved by the federal Department of Housing and Urban Development (HUD). The counselor can look at your situation and help you evaluate your options. You can also call the HOPE hotline for free advice. These trained professionals may have ideas you hadn’t considered or advice you haven’t come across.
- Forbearance. If you’re experiencing a severe but temporary financial hardship, your loan servicer may grant you a short-term suspension of payments.
- Mortgage restructuring (loan modification). This option can help you stay in your home with a more affordable monthly payment. Your servicer may agree to forgive part of your principal, lower your interest rate or extend your loan term. For an example, check out Fannie Mae and Freddie Mac’s Flex Modification program. The downside of a loan modification is that it may leave you with a tax bill for cancellation of debt income, which your servicer will report to you and the IRS on form 1099-C.
- FHA or VA streamline refinance. If you have an FHA or VA loan, you may be able to refinance into the same type of loan even if your income or property value has decreased. An FHA streamline refinance or VA streamline refinance could give you an easier path to a more affordable monthly payment.
- Rent out all or part of the home. If there’s enough demand for rental housing in your area, you might be able to generate enough income from a renter to keep making your mortgage payments. This could be a solution to waiting out a dip in local home values that’s preventing you from selling or to waiting out a drop in income until your circumstances improve. You may need to increase your homeowners insurance coverage if you go this route.
- Short sale. You can attempt to sell the home for whatever the market will bear, even though it’s less than what you owe. Your loan servicer will need to agree to this, and ideally they will forgive the difference and you’ll be able to start over. A short sale is still very harmful to your credit and will mean waiting several years to qualify for another mortgage.
- Bankruptcy. If your financial woes extend far beyond repaying your mortgage, you may want to file for bankruptcy. A chapter 13 bankruptcy will restructure your debt and give you more affordable payments. This process can be a way to save your home from foreclosure, though bankruptcy will still hurt your credit. It will also take as long as five years to complete.