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What Is a Deed in Lieu of Foreclosure? How Does It Work?

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In a Nutshell

A deed in lieu of foreclosure is a legal agreement where a homeowner/borrower gives the legal title of their home to their lender. In exchange, the lender releases 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 January 11, 2022

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 can be used to avoid the foreclosure process. A deed in lieu of foreclosure is a legal agreement between a homeowner/borrower and a mortgage lender. As the borrower, you agree to give your home's legal title to the lender in exchange for being released from your mortgage debt. This means you lose your home, but you’ll also be freed from your mortgage debt. For many people, this is a better outcome than being evicted and having a foreclosure on their record. Both make it more difficult to get another home loan or other financing in the near future.

Many borrowers will first try to get a loan modification or see if their lender will approve a short sale. If neither of these is possible, you may want to consider a deed in lieu of foreclosure, especially if:

  • The fair market value of your home is less than what you still owe on the mortgage loan.

  • You can't pay off the mortgage debt. 

  • You don’t have much home equity, your financial situation isn't 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.

How Does a Deed in Lieu of Foreclosure Work?

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.

If you've already been through the loss mitigation process and it hasn't worked, you may be considering a deed in lieu of foreclosure. As a first step, contact your mortgage lender. Tell them you want to avoid the foreclosure process and ask if it's possible to do a deed in lieu. If the lender is willing to accept a deed in lieu of foreclosure, you'll sign a legal document that transfers the legal title of your property to the lender. Then they'll issue a mortgage release, which shows you’re no longer required to pay your mortgage debt. 

A deed in lieu of foreclosure is a good faith agreement that erases your mortgage debt. While this can be a great relief, it comes at a big cost: You have to give the legal title of your home to your lender so they can sell the property.

Your lender is more likely to accept a deed in lieu of foreclosure if your home is in good condition and its fair market value 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. In this case, you may be required to go through the foreclosure process.

If your mortgage lender accepts your deed in lieu of foreclosure, they'll typically send you a 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 of your own free will and 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'll definitely want to make sure that the deed in lieu of foreclosure has a provision that expressly states that you'll no longer be responsible for paying the mortgage debt, and the lender has absolutely no right or ability to go after you for a deficiency judgment

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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 has consequences. For example, you’ll still lose your home. But you may be eligible for relocation assistance or what's called “cash for keys.” Cash for keys is an agreement with your mortgage lender that you'll 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. 

Tax Consequences

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 forgiven debt as taxable income.

Damage to Credit

Ultimately, you’re going to be looking at some damage to your credit score. It'll likely be more difficult 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. 

Deficiency Judgment

Laws differ by state. In some states, your mortgage company can pursue a deficiency judgment against you. If so, you'd 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?

Like filing bankruptcy, a deed in lieu of foreclosure isn't something you want to rush into. Both are a last resort to prevent a foreclosure sale and the 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're falling behind on your mortgage payments. The Consumer Financial Protection Bureau and other homeowner assistance organizations are good resources to consult.

If you've 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.

Preventing Foreclosure With a Short Sale

You may also be able to use a short sale to avoid foreclosure. In a short sale, you sell your home for less than what you owe on your mortgage. This is more drastic than refinancing or modifying your home loan. Like in a deed in lieu agreement, in a short sale, you move out of your home and the lender relieves you of your mortgage debt. Each process works a differently, though.

In a short sale, you request a loss mitigation application from the servicer. You, the borrower/homeowner, have to inform the lender or loan servicer of your financial situation and the hardship you’re going through. You also have to demonstrate that you have an offer on the home from an interested buyer.

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:

  • Refinance.

  • Ask for a payment forbearance.

  • Do a loan modification.

  • Attend mortgage counseling.

  • Agree to a repayment plan with the lender.

  • Sell the home.

Let’s Summarize...

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. You can handle this, learn from it, and be on your way to a better standard of living for you and your family.

Written By:

Attorney Eric Hansen

Eric D. Hansen is an experienced Minnesota attorney within a number of varying and nuanced practice areas. He has operated his own solo practice as well as worked at small suburban boutique firms and large diversified downtown law firms. Eric has a wealth of experience in busines... read more about Attorney Eric Hansen

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