Deed in lieu of foreclosure: What is it and is it right for you?

Your lender will have to act if you fall behind on your mortgage payments. A deed in lieu agreement might help you avoid the repercussions of a foreclosure. A foreclosure is the legal process in which the lender who owns your mortgage takes your property back.

Let’s look at how a deed in lieu agreement works and how it differs from a foreclosure. We’ll also show you a few alternative ways to avoid foreclosure without a deed in lieu agreement.

What is a deed in lieu of foreclosure?

A deed in lieu agreement is an arrangement that gives your mortgage lender the deed to your home. Homeowners agree to deed in lieu agreements to avoid foreclosure.

Foreclosures show up on your credit report. This can make it virtually impossible for you to buy another home for years. A deed in lieu of foreclosure can also show up on your credit report and negatively impact your credit score. This may affect your ability to obtain another mortgage depending on the lender and mortgage product.

When you hand over the deed, the lender removes the property lien and takes ownership of your home. This allows the lender to recoup some losses without forcing you into foreclosure. The lender also relieves what you still owe on the mortgage. Many homeowners seek deed in lieu agreements when their mortgage ends up “underwater.” An underwater mortgage means a borrower owes more on their home than it’s worth.

Reasons a lender might reject a deed in lieu

It’s important to remember your lender has no obligation to accept a deed in lieu agreement. Some of the reasons why a lender might reject a deed in lieu include:

• A depreciated home value: If your home’s fair market value has gone down, you might owe more than your home is worth. In this case, a lender may agree to accept a deed in lieu agreement. However, your lender might only accept the deed in lieu if you pay the difference between the appraised value and what you owe. Rocket Mortgage® doesn’t do this.

• Liens or tax judgments on your property: It becomes more complicated if you have a judgment or secondary lien. This is a claim to your property the lender didn’t make. Some lenders will work with you to clear the lien if they see someone else has a claim on the property.

• Poor home condition: If your home is in poor condition, your lender could reject any deed in lieu agreement you propose.

Reasons a lender might accept a deed in lieu

Though a lender isn’t obligated to accept your deed in lieu of foreclosure, they have a few incentives. Some of the benefits your lender gets when they take a deed in lieu include:

• Faster control over your property: With a foreclosure, lenders must pay attorneys to go to court to prove you haven’t been paying your bills. Then they need to get approval from the court to take your property. The lender must also legally evict you from the property, even after they’ve already gone to court. Your lender saves both time and money by taking a deed in lieu.

• Better property conditions: Lenders may agree to take control of properties in good condition. That’s because these properties sell for more money and spend less time on the market. A lender will sometimes stipulate that you must keep the property in good condition with a deed in lieu.

Deed in lieu vs. foreclosure: What’s the difference?

A deed in lieu and a foreclosure have different processes and repercussions for homeowners. Let’s examine their differences below.

Deed in lieu agreement

A deed in lieu means you and your lender reach a mutual understanding that you’re no longer able to make your mortgage payments. The lender agrees to avoid putting you into foreclosure when you hand the property over amicably.

In exchange, the lender releases you from your obligations under the mortgage. Your lender might even offer you a bit of financial assistance as an incentive to keep the property in good shape before you leave.

Though a deed in lieu will show up on your credit report, its impact isn’t as severe as a foreclosure.

Foreclosure process

Your lender must go through the proper legal channels to take back control over the property through the foreclosure process. This can come with many drawbacks for the client if it gets to that point.

For example, a foreclosure will impair your credit score and stay on your credit report for 7 years. During this time, it will be extremely difficult for you to buy another home unless you can pay cash for the home. Your lender may or may not offer you a financial incentive to leave the property if you allow the home to go into foreclosure.

Remember, a foreclosure proceeding is a long and expensive process for both you and the lender. You should consider all of your options very carefully before you agree to give up the deed to your home. In many cases, it’s best for both you and the lender to restructure your mortgage instead of pursuing a foreclosure.

Contact a Housing and Urban Development (HUD) housing counselor or a defense attorney who specializes in foreclosures before deciding on a deed in lieu or foreclosure.

Is deed in lieu of foreclosure right for you?

Whether you should take a deed in lieu depends upon your unique situation. Let’s look at some of the benefits and drawbacks.

Benefits of a deed in lieu

• Minimization of your deficiency: A deficiency is the negative difference between what you owe on your home and what it’s worth. A deed in lieu can eliminate your deficiency if you owe more on your home than the home is worth. In exchange for giving the lender your deed voluntarily and keeping the home in good condition, your lender may agree to forgive your deficiency or greatly reduce it.

• Potential for moving assistance: Lenders want control of your property when it’s in the best condition possible. Many lenders offer “cash for keys” agreements. These help you find a new place to live when you forfeit your deed without damaging your home.

• Less damage to your credit: A deed in lieu stays on your credit report for 7 years while a foreclosure stays for 7 years. A deed in lieu agreement can allow you to buy a new home sooner than if you go through a foreclosure.

Drawbacks of a deed in lieu

• Loss of your home: Your lender removes your name from the title of your home when you take a deed in lieu of foreclosure. This arrangement isn’t right for you if you still want to live in your home.

• No guarantee of acceptance: Your lender isn’t obligated to accept your deed in lieu of foreclosure.

• Negative impact on credit: While a deed in lieu won’t harm your credit as much as a foreclosure, still expect your score to drop. You also won’t be able to easily get another mortgage if you have a deed in lieu on your credit report.

• Potential tax money owed on your forgiven loan balance: If your lender forgives more than $600 of deficiency, the IRS considers it income. You’ll likely have to pay income tax on any deficiency your lender forgives when you pay taxes.

Other ways to avoid foreclosure or deed in lieu

A deed in lieu isn’t the only way to get mortgage help and avoid foreclosure. Let’s examine a few other options you have when you can’t make your mortgage payments.

Loan modification

A loan modification might be right for you if you can’t make your mortgage payments, but you want to remain in your home. A loan modification means your lender changes the interest rate on your mortgage loan to match current market rates.

You may owe more on your home than it’s worth. In that case, your lender may be able to put the excess principal in a forbearance account.

While in forbearance, the excess principal doesn’t build interest. This can stop you from falling further into mortgage debt while you pay off what you owe. The amount in forbearance is due when you pay off the rest of the loan.

Like a deed in lieu agreement, a lender isn’t obligated to modify your loan or allow a mortgage forbearance instead of foreclosing. Work with your lender to try to find a solution that’s beneficial for both of you.

Short sale

You may be able to sell your home through a short sale if you can’t get a modification, or if you don’t want to stay in your home. A short sale means you sell the home for less than the amount left on your mortgage.

Most short sales take place because property values have gone down in an area. During a short sale, you communicate with buyers, show your home and talk with real estate agents just like a normal sale. However, unlike a normal sale, your lender needs to approve the short sale before it goes through.

You may still owe money after a short sale. If you have a deficiency balance, your lender may sue and take you to court to get a deficiency judgment. If you can’t pay the difference between your remaining loan balance and your home’s sale price, ask your lender to waive their right to sue for deficiency. Some states (like California) have laws that ban deficiencies after a short sale.

The bottom line

A deed in lieu agreement might help you move out of your home and avoid foreclosure. When you take a deed in lieu agreement, you transfer your home’s deed to your lender voluntarily. In exchange, the lender agrees to forgive the amount left on your loan.

A deed in lieu agreement won’t stay on your credit report like a foreclosure. However, your lender must first agree to take the deed in lieu of foreclosure; they’re under no obligation to accept your terms. You can improve your chances of acceptance by keeping your home in good condition.

You can stay in your home with a loan modification if you don’t want to take a deed in lieu. But you may also sell your home with a short sale if you can’t make a modification work for you.

Remember, everyone’s financial situation is different. It’s best to speak with a licensed financial expert or adviser before making any major financial decisions.

Have questions or need some help with your mortgage? Speak with a Home Loan Expert today.