A deed in lieu of foreclosure is a legal agreement in which you, the homeowner/borrower, give the legal title of your home to your lender. In exchange, they release you from your mortgage debt. While you’ll still lose your home as a result of this process, you’ll be relieved of your mortgage debt obligations and responsibilities. Read more to learn about the benefits and consequences of a deed in lieu of foreclosure and to find out if it's a good option for you.
Written by Attorney Eric Hansen.
Updated September 16, 2021
You’ve probably heard the term foreclosure before. But you might not have heard of a deed in lieu of foreclosure. If you don’t want to file bankruptcy but you’ve fallen behind on your mortgage payments and haven’t been able to modify or refinance your home loan, you may be able to avoid foreclosure by agreeing to a deed in lieu of foreclosure. Losing your home through foreclosure or a sheriff’s sale is not only stressful, but it can also have negative consequences for your credit score and prevent you from getting future loans. As you’ll see in this article, a deed in lieu of foreclosure can help you avoid those negative effects when done correctly.
What Is a Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure is a legal agreement in which you, the homeowner/borrower, give the legal title of your home to your lender. In exchange, they release you from your mortgage debt. While you’ll still lose your home as a result of this process, you’ll be relieved of your mortgage debt obligations and responsibilities. This outcome can be preferable to the alternative of being evicted and having a foreclosure on your record that will make it difficult for you to get another home loan or other financing in the near future.
If you have not been able to get a loan modification and/or your mortgage lender has rejected a short sale, you may want to consider a deed in lieu of foreclosure. A deed in lieu of foreclosure is best used under the following conditions:
The fair market value of your home is less than the amount you still owe.
You are not able to pay off the mortgage debt.
You don’t have much home equity, your financial situation is not looking good, and you want to minimize your loss as much as possible.
You’ve tried refinancing in good faith and you’ve talked to a housing counselor.
So, when you’re looking at a possible deed in lieu of foreclosure, you would approach your mortgage lender, perhaps after a forbearance didn’t help or work out. If your lender was willing to accept a deed in lieu of foreclosure you would sign off on a legal instrument or document that transferred the legal title to your property to the lender. Then they would issue a mortgage release, showing you’re no longer required to pay your mortgage debt.
How Does a Deed in Lieu of Foreclosure Work?
A deed in lieu of foreclosure is an option for those seeking to avoid the foreclosure process. First, you’ll want to talk with the mortgage servicer and ask for a loss mitigation application. You’ll need to demonstrate your financial hardship and have evidence of your income and family budget. Homeowners must get the same loss mitigation application from a servicer when they are considering a short sale.
A deed in lieu of foreclosure, if accepted by your lender, is a good faith agreement that erases your mortgage debt, but you have to give something up in exchange. You have to give the legal equitable title of your home to your lender so that they can sell the property at a later date.
Your lender is more likely to accept a deed in lieu of foreclosure if your home is in good condition and the fair market value of the real property is high. A lender might not be as willing to accept a deed in lieu of foreclosure if your home loan is backed by a government-sponsored guarantor like Freddie Mac or Fannie Mae, as there might be a requirement that you have to go through the foreclosure process and not a deed in lieu of foreclosure.
If your deed in lieu of foreclosure is accepted by your mortgage lender, they will typically send you a couple of different documents including the deed in lieu of foreclosure document and sometimes a document called an estoppel affidavit. An estoppel affidavit protects everyone involved by making it clear that you're voluntarily transferring your property to the bank. These documents have specific provisions that indicate that you are acting under your own free will and that no one is forcing you to complete a deed in lieu of foreclosure.
Take the time to read the legal documents carefully. You may want to have an attorney or a housing counselor assist you with these important legal documents. You will definitely want to make sure that the deed in lieu of foreclosure has a provision that expressly states that the transfer of real property completely satisfies the mortgage debt and that the lender has absolutely no right or ability to go after you for a deficiency judgment.
Consequences of a Deed in Lieu of Foreclosure
Although it doesn’t have quite as much of a negative impact as an ordinary foreclosure, a deed in lieu of foreclosure still comes with consequences. For example, you’ll still have to give up possession of your home to the bank. But you may be eligible for relocation assistance or what is called “cash for keys.” Cash for keys is an agreement with your mortgage lender that you will move out on a certain date and leave the home in good condition in exchange for a sum of money. This is quicker and cheaper for your mortgage lender than having to pursue an eviction and pay to fix up the real estate.
When you successfully complete a deed in lieu of foreclosure, there may be tax consequences. Although the mortgage lender is erasing your mortgage debt, you may have to pay taxes on the canceled or forgiven debt. That’s because the IRS classifies this forgiven debt as taxable income. Be sure to alert your tax preparer or accountant when tax season comes around.
Damage to Credit
Ultimately, you’re going to be looking at some damage to your credit score. It will likely be more difficult for you to get another mortgage in the near future as well. Though these are negative consequences, they pale in comparison to those from the foreclosure process.
Laws differ by state. In some states, it’s possible for your mortgage company to pursue a deficiency judgment against you. If so, you would be responsible for any outstanding mortgage debt up to the amount of the loan, interest, and fees once the foreclosure sale price is subtracted from the outstanding mortgage debt. A deficiency judgment following a foreclosure can negatively impact your family’s financial situation.
Do I Want a Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure is not something you want to rush into. It is a last resort option, along with filing bankruptcy, to prevent a foreclosure sale and the related negative consequences. Try to learn as much as you can about all of your options, be proactive, and reach out for help as soon as possible if you are falling behind on your mortgage payments. The Consumer Financial Protection Bureau and other homeowner assistance organizations are good resources to consult and have a lot of information on deeds in lieu of foreclosure, short sales, foreclosure, and other consumer credit matters.
If you have already tried refinancing, forbearance, loan modification, or a short sale, you may want to consider a deed in lieu of foreclosure. It can help you achieve a good outcome from a bad situation, so it is something to consider if you have exhausted all other options. As the name deed in lieu of foreclosure suggests, it is really a compromise in which each party gets something of value, even if it isn’t all that you want or your lender wants. It’s still a win-win situation compared to the lose-lose situation of the foreclosure process.
Preventing Foreclosure With a Short Sale
A short sale may also be able to help you avoid foreclosure. It is more drastic than refinancing or modifying your home loan. Like in a deed in lieu agreement, in a short sale you’ll end up moving out of your home and being relieved of your mortgage debt. It works a bit differently though.
In a short sale, you’ll request a loss mitigation application from the servicer. You, the borrower/homeowner, will have to inform the lender and servicer of your financial situation and the hardship you’re going through. You will have to demonstrate that you have an offer on the home from an interested buyer. In a short sale, you are selling your home for less than what you owe on your mortgage.
The lender has to agree to the short sale process and accept the purchase price. To complete the transfer and give the new homeowner legal title to the real estate, the lender issues a mortgage release so that there is no longer a lien on the property or a security interest.
Are There Other Mortgage Relief Options?
Borrowers have several other mortgage relief options. In addition to a deed in lieu of foreclosure, a short sale, and bankruptcy, consider the following mortgage relief options:
Sale of the home
A deed in lieu of foreclosure can be a powerful tool to prevent the stressful and financially harmful foreclosure process. Remember that you as the borrower/homeowner are giving up your legal title to the home and agreeing to find different housing in exchange for the lender forgiving your outstanding mortgage debt.
By utilizing a deed in lieu of foreclosure you can prevent your financial situation from becoming worse and avoid the serious negative impacts of foreclosure. Be thoughtful as you navigate your options, carefully read the fine print, and act before it is too late. You can handle this, learn from it, and be on your way to a better standard of living for you and your family.