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

If you fall behind on paying your mortgage, expect your lender to take action. They may even attempt to legally take back your house via foreclosure, a serious consequence that can significantly impact your life. But if you face financial hardship, you may be able to avoid a foreclosure by applying for a deed in lieu of foreclosure.

In this guide we’ll explore how a deed in lieu of foreclosure works, the difference between a deed in lieu of foreclosure and foreclosure, as well as the pros and cons of this strategy.

What is a deed in lieu of foreclosure?

A deed in lieu of foreclosure is a voluntary arrangement in which you agree to give your mortgage lender the deed to your home to avoid foreclosure, which is involuntary. When you hand over the deed, your lender removes its property lien and takes ownership of your home. This allows the lender to recoup some of its losses without trying to forcefully repossess your property. You may be fully cleared of your mortgage debt if your lender specifically agrees in writing not to sue you for any remaining balance.

Rocket Mortgage may consider a deed-in-lieu if a loan is delinquent.

Note that a foreclosure will show up on your credit report. This can make it virtually impossible for you to buy another property for years. A deed in lieu of foreclosure can also show up on your credit report and negatively impact your credit score. This may also hurt your chances of obtaining another mortgage, depending on the lender and mortgage product.

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

A deed in lieu and a foreclosure work differently and have different repercussions for homeowners. In order to complete a deed in lieu you will need to go through an application process and have it approved by your lender.  Here, you agree to hand over your property deed, and the lender agrees to avoid foreclosing on your property. In exchange, the lender may release you from your obligations under the mortgage, provided the agreement includes a written waiver of any remaining debt. Your lender might even offer you a bit of financial assistance as an incentive to keep the property in good shape before you leave. While a deed in lieu will show up on your credit report similarly to a foreclosure, it is often viewed more favorably by future lenders and may allow you to buy another home sooner.

With a foreclosure, your lender must go through the proper legal channels to regain control over your property. This 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 property 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. Rocket Mortgage does not offer any financial incentives if a property goes into foreclosure. Remember, a foreclosure proceeding is a long and expensive process for both you and the lender. You should consider all 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.

“(A deed in lieu) is generally viewed as slightly less damaging because it reflects a cooperative resolution rather than a full legal battle,” Lokenauth adds.

When facing financial hardship, explore all your options. Contact a Housing and Urban Development (HUD) housing counselor or an attorney who specializes in foreclosures before deciding on a deed in lieu of foreclosure.

How does a deed in lieu of foreclosure work?

Not everyone is allowed to offer their deed in lieu of foreclosure, and acceptance of it will depend on your lender’s discretion.

Qualifications 

Some of the factors that lenders may look at with respect to a deed in lieu of foreclosure:

• Financial hardship and inability to pay. One of the main things lenders will look at is the reason why you are unable to make your existing mortgage payments. Your lender will look to see if you have a qualifying hardship, typically a situation that was unavoidable or outside your control, which then causes the financial hardship – such as a job loss, divorce, unexpected medical expenses, or the death of a spouse.
• Good faith attempt to sell your home. Most lenders will want to see that you made a “good faith” attempt to sell your property before requesting a deed in lieu. That typically means your home was listed for at least 3 to 4 months on the market and was not sold at a price that would help you pay off the loan.
• Property condition. Because your lender will likely sell the home after the ownership transfers, they want to confirm that the property is in reasonable condition. They’ll look to see that your home could be sold for a fair price without them needing to spend money on repairs or upgrades. The home would need to be in “broom swept” condition, which means nothing needs to be removed and all furniture and personal belongings have already been taken out of the house.
• No additional liens. Your lender will want to confirm that there are no additional liens on the property that they would be responsible for if they take ownership of your home, such as tax liens or second mortgages.
• Property type and status. Some lenders will only consider a deed in lieu if the property is your primary residence. Depending on the lender and loan type, second homes or investment properties may not qualify.

Steps to submit a deed in lieu of foreclosure

Ready to move forward with this arrangement? Here are the common steps involved, in order:           

1. Contact your servicer. You will need to explain and demonstrate your financial situation to explore possible options long before you reach out to initiate a deed in lieu of foreclosure. Depending on your unique financial situation, there may be other choices available to you. Remember a deed in lieu is not an automatic right. The lender must agree to the deed in lieu. Should you determine that this option is the one you believe is best for you, work with your servicer to find out what kind of documentation you need to apply.
2. Consider speaking with an attorney. Although this is not required, it’s often in your best interest to consult with a lawyer before agreeing to a deed in lieu of foreclosure. An attorney can help you understand whether this is truly your best option and explain other alternatives that may be available. If you decide to move forward, the attorney can also help guide you through the process, prepare your application, and negotiate with the lender to ensure the terms are fair. You can also reach out to HUD to obtain financial counseling.
3. Satisfy eligibility requirements. Review your lender’s eligibility requirements and take the necessary steps to ensure you satisfy them. For example, if your lender requires that you have made a good faith effort to sell your home first, make sure your home has been listed to match their criteria.
4. Submit the application. Your lender will likely require you to complete an application to request a deed in lieu. You may need to explain your financial hardship and provide supporting documentation, including income statements, tax returns, bank statements, or other documents showing why you are no longer able to afford mortgage payments.
5. Conduct a title search. If your initial application is approved, your lender will have a title search performed to determine if there are any additional liens on your property.
6. Have the home appraised. Your lender will request an appraisal or broker’s price opinion to calculate your home’s current value, which can help them determine whether accepting your deed makes sense.
7. Negotiate the terms of the agreement. This can include things like the value the property will be transferred for, how long you have to move out after the deed is signed, whether the lender will forgive any remaining mortgage balance after taking over the property, and how the situation will be reported to the credit bureaus.
8. Sign the deed in lieu agreement. After all terms are finalized, you’ll need to sign the deed in lieu agreement and related documents, likely in front of a notary. At that time, ownership of your property will be transferred to the lender.

Reasons a lender might reject a deed in lieu

Remember: Your lender has no obligation to accept a deed-in-lieu agreement. Some of the reasons why your deed in lieu can be rejected include:

• A depreciated home value: If your home’s value has dropped and you owe more than it's worth, a lender might still consider a deed in lieu. However, some lenders may only move forward if you pay the difference between the home's appraised value and your total debt, though Rocket Mortgage doesn't follow this requirement.
• Liens or tax judgments on your property: The process is more difficult if there is a secondary lien or a judgment against the property from a third party. While these are claims the primary lender didn't make, some may still work with you to clear these titles so the deed transfer can proceed.
• Poor home condition: Your lender will also prioritize the state of the asset before agreeing to an alternative to foreclosure. If your home has significant damage or is in poor condition, your lender might reject your proposal for a deed in lieu entirely.

"Another reason they may reject a deed in lieu of foreclosure is if the lender determines that a foreclosure process could result in a better financial recovery for the outstanding loan balance,” adds Shirshikov.

Reasons a lender might approve a deed in lieu

Though your lender isn’t obligated to accept your deed in lieu of foreclosure, they have a few incentives to do so. When they approve, your lender can benefit by:  

• Avoiding expensive legal fees. 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.
• Avoiding an eviction. The lender must also legally evict you from the property, even after they’ve already gone to court. Your lender saves time taking a deed in lieu.
• Taking over an improved property. Lenders may agree to take control of properties in good condition. That’s because these properties 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.

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. Rocket will only consider a deed in lieu for a property where the owner cannot maintain payments and will not accept a deed in lieu if more is owed on the loan than the property is worth.
• 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. “I’ve seen lenders offer relocation assistance, sometimes $3,000 to $10,000 or more, to help the homeowner move out cooperatively,” says Lokenauth.
• Less damage to your credit: A deed in lieu stays on your credit report for 7 years, and so does a foreclosure. A deed in lieu is seen as slightly less damaging to your credit, so it may 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 won’t work if you still want to live in your home.
• No guarantee of approval: Again, your lender isn’t obligated to approve 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, you can 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. We will examine other ways to work with your servicer and lender if you’re facing financial hardship.

In addition to the options below, there may be additional programs available to you. Clients should call their servicer if they cannot make their mortgage payment to discuss all the options available to them. Some of the assistance programs can be found here.

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.

With a loan modification there is a change in the terms of your loan, but this is different than refinancing your loan, which means paying off your loan and obtaining a new loan. With a loan modification, you will document your financial situation for your servicer to demonstrate your financial hardship.

With this relief option, missed mortgage payments are often added back into the principal of the loan or the term may be extended to make payments more affordable. This type of program is not automatic, and you must contact your servicer to apply.

Loan modification is different than forbearance. With forbearance, the lender temporarily approves the reduction or suspension of payments to allow the borrower to get their finances in order. Depending on the terms approved by the lender, you may have to make increased payments or a large payment to catch up on what you owe when this period is over. Again, you would have to document your financial situation, and you would have to contact your servicer to apply.

If you believe you may face financial hardship, it’s always best to contact your servicer as early as possible to avoid defaulting on your loan.

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. Unlike a normal sale, your lender needs to approve the short sale before you list your home for sale.

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 the 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 of foreclosure could protect your financial future

A deed in lieu of foreclosure can allow you to move forward with a plan to exit your home while minimizing foreclosure’s impact on your credit report. When you voluntarily transfer the deed to your property to your lender, you may secure forgiveness of any remaining mortgage debt, though you should get a waiver to protect yourself from any future claims.

Your lender isn’t obligated to approve this kind of agreement. Since everyone’s financial situation is different, consult with a qualified financial professional or an attorney before committing to this choice.

If you still have questions or need some help with your mortgage, you can speak with a Rocket Mortgage Home Loan Expert today.