Voluntary foreclosures are often preferred over traditional foreclosures because they can save time, money, and stress for all involved. But despite these benefits, borrowers should carefully consider the potential drawbacks.
Written by Attorney Curtis Lee.
Updated October 11, 2021
In the majority of home foreclosures, the bank or lender decides to foreclose on a property and begins the process. But in some cases, the borrower decides to have the lender foreclose. Why would a homeowner do this? In most situations, it’s because it makes financial sense to do so. Perhaps the homeowner can no longer afford the home or maybe it’s become a losing investment. Either way, the borrower believes they’ll be financially better off with a voluntary foreclosure.
What Is a Voluntary Foreclosure?
In a traditional foreclosure, the bank or mortgage company decides to foreclose on a property and starts the process. This often occurs after the borrower misses several mortgage payments and is in default.
But with voluntary foreclosure, the borrower initiates the process. They’ve often made attempts to sell the real estate at a reasonable price and failed, or they know the selling process would take too long. So the borrower allows the property to go into foreclosure because they’re unable or unwilling to continue making loan payments. But just like a traditional foreclosure, the lender takes possession of the property from the borrower.
A voluntary foreclosure sometimes goes by other terms, such as:
Jingle mail (the homeowner puts the keys to the house in an envelope and mails it to the lender)
The first three scenarios usually occur when the homeowner can’t afford to continue making the mortgage payments. But a strategic default is different. It often applies to homeowners who can afford to keep the property and avoid foreclosure, but they decide not to. This strategic decision to stop making mortgage payments is often because the home has become a bad investment and the mortgage is underwater.
Why Would a Homeowner Voluntarily Give Up Possession of Their Property?
When it comes to financial decisions, each person’s thought process is different. But if a homeowner chooses voluntary foreclosure, it’s probably due to one or more of the following reasons.
The mortgage is underwater.
Also called an upside-down mortgage, an underwater mortgage occurs when a borrower owes more on their mortgage loan than the home is worth. This also means that there’s no equity in the home. This poses a problem for the lender because the home no longer has enough value to cover the mortgage debt in case there’s a default. It’s bad for borrowers because they have a property that requires a significant monthly payment while offering them no financial value beyond a place to live.
An underwater mortgage can happen when a borrower defaults and additional interest and late fees get added to their loan balance. If the homeowner has little equity in the home before the default, these additional costs can be enough to turn the mortgage upside down. More often, a mortgage is underwater because of changes in the housing market.
The housing market has changed.
Changes in the housing market can increase or decrease a home’s fair market value. For example, homebuilders may have trouble getting supplies to build new homes, which results in a shortage of homes for sale. Assuming the demand for homes remains the same, the price of existing homes will go up. In other words, the existing home’s fair market value increases.
But changes in the housing market can also cause home prices to fall. For instance, if interest rates are increased, it’s harder for potential home buyers to get mortgages. And if they get approved, the loan amount could be smaller, reducing the number of houses they can afford.
Home values may also drop if there’s an economic downturn. Economic slumps often lead to more foreclosures. It’s bad enough that foreclosed homes tend to lower the values of neighboring homes. But it also creates an additional supply of houses, which can further decrease the value of existing homes.
The homeowners’ finances have changed.
To get approved for a mortgage, a lender will check a homeowner’s finances to ensure they have the means to make their monthly mortgage payments. But throughout the mortgage, the homeowner’s finances can change. There might be a loss in income, an increase in expenses, or a combination of the two.
If the borrower or a member of their household loses a job, it can sometimes mean they can no longer afford to pay their mortgage. Other times, they may accumulate too much debt. The monthly bills and money spent on interest then become so large, there’s nothing left to make the mortgage payments. Then there’s the situation where the mortgage has an adjustable interest rate. If this goes up significantly, the mortgage payment could rise to an amount the homeowner can no longer afford.
It’s taking a psychological toll.
If the borrower is resourceful, they might find a way to avoid foreclosure and keep the home. But it might require sacrifices that the borrower isn’t willing to make. In this case, they might decide to cut their losses and walk away from the mortgage to get a fresh start. This is more for psychological reasons than financial ones. Mounting financial challenges can take a psychological toll on borrowers, so finding a way to relieve that stress can be priceless.
It makes financial sense.
With some voluntary foreclosures, the homeowner can afford to continue paying their mortgage. But they choose to let the bank foreclose on the property because, in the long run, it saves the homeowner money. Yes, their credit score will take a hit. And there’s a good chance they’ll have to pay additional money if the value of the property is less than the mortgage balance. But if the home has lost significant value and will continue to do so for the foreseeable future, getting out from the mortgage as soon as possible could be a wise financial decision as the lesser of two evils.
How Does a Homeowner Transfer Their Property to the Mortgage Lender?
The deed in lieu of foreclosure is the most common method for voluntary foreclosures. The exact terms of the deed in lieu of foreclosure will vary, based on applicable state law and the mortgage’s terms. But generally speaking, a deed in lieu is when the homeowner agrees to give the title to their property to their mortgage lender. In return, the lender releases the homeowner from the mortgage.
The homeowner no longer has to make any mortgage payments, but they’ll have to leave the property by a set time. How long they have will depend on their agreement with the lender.
A lender isn’t required to accept a deed in lieu of foreclosure offer from the borrower. But sometimes they’ll accept it because it can save them the time and money required to do a regular foreclosure. This is especially true if the lender has to go through a judicial foreclosure and the homeowner plans on fighting it. Even if the bank wins in court, it could take years and thousands of dollars in legal fees before the bank can complete its foreclosure.
If you’re thinking about using a deed in lieu of foreclosure, you’ll want to exhaust your other possibilities first, such as:
These options might work out better for you, and lenders might also require that you try them before they’ll agree to a deed in lieu of foreclosure. If your lender is willing to accept a deed in lieu of foreclosure, you still need to weigh its advantages and disadvantages to see if it’s a worthwhile solution for you.
Advantages of Using a Deed in Lieu of Foreclosure
A deed in lieu of foreclosure offers several benefits, for both borrowers and lenders. Depending on your financial situation and ability to find a new place to live, some of these advantages will be more important than others.
You can stop making mortgage payments. This is probably the biggest benefit of a deed in lieu of foreclosure.
Lenders can save time and money by skipping the foreclosure process, which may make them more likely to agree to a deed in lieu.
As part of the deed in lieu of foreclosure agreement, a lender might also provide cash assistance to help you relocate and provide an incentive to leave the property in as good condition as possible. These types of arrangements are also known as cash for keys.
The deed in lieu of foreclosure is a proactive step to avoid foreclosure. This might make it easier for you to leave your home with more dignity and less embarrassment.
It could do less harm to your credit compared to a regular foreclosure. Prospective lenders may also view a deed in lieu of foreclosure less harshly than a traditional foreclosure. There’s also the fact that it’ll be easier to get a mortgage in the future. For instance, the waiting period for a Fannie Mae loan is four years. If you lose your home to an involuntary foreclosure, the waiting period extends to seven years.
Disadvantages of Using a Deed-in-Lieu to Transfer Ownership to Lender
Despite the numerous benefits of a deed in lieu of foreclosure, it has several drawbacks. These may not be enough to reject the deed in lieu of foreclosure, but they could result in consequences you need to be aware of and prepare for.
The credit impact of the deed in lieu of foreclosure will be severe and you should expect a substantial drop in your credit score. Depending on the facts of your voluntary foreclosure, the negative impact could be comparable to a regular foreclosure.
Because a deed in lieu of foreclosure will be a negative mark on your credit report, it could make it harder to find a place to rent or to buy a future home.
If you apply for a job that does a credit check on job applicants, it may reduce a future employer’s willingness to hire you.
If your mortgage is underwater, your lender may get a deficiency judgment against you and force you to pay the deficiency balance.
If your lender forgives part or all of a deficiency balance, the IRS could consider the amount of the canceled debt as a form of taxable income.
Not all of these disadvantages will apply to you. But you should consider the potential for each one before you agree to a deed in lieu of foreclosure. If you’re not sure if or how one of these drawbacks could affect you, don’t hesitate to speak to a credit counselor or an attorney who specializes in foreclosure or bankruptcy.
A homeowner, not a lender, starts the voluntary foreclosure process. They do this because they’re unable or unwilling to make mortgage payments on their home. As a result, they may voluntarily transfer the title of their home to their lender. In return, the borrower gets released from their mortgage payments.
Voluntary foreclosures are often preferred over traditional foreclosures because they can save time, money, and stress for all involved. But despite these benefits, borrowers should carefully consider the potential drawbacks. Additionally, there could be other debt-relief options that can help a homeowner continue to make their mortgage payments, keep their home, and protect their credit.