Deed In Lieu Of Foreclosure

As we noted on the What Is A Foreclosure? webpage there are several types of foreclosures.  We discussed a Foreclosure by Judicial Sale (also known as a Judicial Foreclosure), Strict Foreclosure, Foreclosure by Power of Sale, and Deed in Lieu of Foreclosure.  This page will be dedicated to speaking about Deed in Lieu of Foreclosure.  If you have any questions after reading the article feel free to go to our  Contact Us page or press the banner to the right and fill out the form to receive your free consultation from a legal professional .  Prior to beginning the article we want to briefly reiterate the four types of foreclosure.

Deed in Lieu of Foreclosure- When a borrower voluntary files for foreclosure on their home.

Foreclosure by Judicial Sale (Judicial Foreclosure) - is the process of the bank (lender) launching the legal process to sell the borrower’s home under the supervision of the court because of the homeowner’s failure to comply with terms and conditions of the loan agreement (paying their monthly mortgage) signed by both parties upon purchase of the home. 

Foreclosure by Power of Sale (Non-Judicial Foreclosure) – Foreclosure by power of sale occurs when the borrower defaults on his/her loan and the lender, per terms of the contract, initiates the right to sell/auction the home without going through the judicial process. 

Strict Foreclosure – Strict foreclosure-Please note this option is involved only when the home/property is valued for less than the loan.  Many states allow the homeowner to appeal the judicial decision on foreclosure.  If the outcome favors the homeowner the court will set a hard date for the borrower to pay their current and past due mortgage payments to the borrower.  If the homeowner fails to meet their obligation the lender will obtain title of the property.

A deed in lieu of foreclosure is an option, which is very similar to a non-judicial foreclosure, that many borrowers are unaware exists as an option for foreclosure.  Based upon our discussion with our professionals and the research we have performed a deed in lieu of foreclosure is not the best option, however, the benefits associated with a deed in lieu make it a viable option for a borrow if their other options are less beneficial.  Many people refer to a deed in lieu of foreclosure as “turning in the keys to your home”.  Essentially, the borrower approaches the lender and gives them keys to their home and walk away.  In theory this may sound great on the surface, but if walk up to the lender and walk away from your home there is consequences.

If borrower is able to prove to your lender that you should be approved for a deed in lieu of foreclosure then they are agreeing to allow the homeowner to turn over the deed which surrenders the title to their house and/or property prior to foreclosure.  In return the lender releases the borrower from any remaining debt, late fees, and interest they owe on the loan.

First, we are going to discuss the advantages of obtaining a deed in lieu of foreclosure for a borrower.  When a borrower persuades a lender to accept a deed in lieu they are forgiven for all the outstanding debt associated with their loan.   Therefore, a lender is not allowed to come after a deficiency judgment on the borrower.  A deficiency judgment is when a lender sues a borrower for the remaining balance on the mortgage (X) after the home is sold in foreclosure (Y) or the appraisal value (Y) (which ever difference is greater (X-Y=Z)).  It should also be noted if a borrower has lived in their home greater than five to seven years the mortgage value is normally less than the purchase price of the property, however, the outstanding mortgage balance could be greater than the market value of the property when the borrower includes the late, legal, and accrued interest fees.

 A borrower’s credit score will suffer a less devastating decrease compared to if they had received a foreclosure remark on their credit report.  This is very important because when the borrower has regained financial stability a lender will be more willing to negotiate a loan and will give more favorable rates with a person who has a deed in lieu on their credit report over someone who has foreclosed on their property.  The credit report will show the debt as paid which signals to future lenders that you are a borrower who meets their financial obligation.  Finally, a deed in lieu of foreclosure is not public knowledge whereas people are made aware of a foreclosure.

Next, we are going to discuss the advantages to the lenders.  First, a lender prefers a deed in lieu because it saves them tons of time and money that is normally spent on court costs.  If a borrower obtains the appropriate legal counsel they can tie their case up in the courts for almost two years.  Lenders want to avoid this at all costs because they do not want to spend the time and money in court in addition to the fact the borrower is living on the banks property mortgage and rent free.  Second, the banks will accept a deed in lieu of foreclosure when they know they will not be able to collect the money from a deficiency judgment.  This leads us to the final advantage for the lender which is they will receive all the equity you have in your home (i.e. land value increase, new kitchens, bathrooms).

The requirements for a Deed in Lieu of Foreclosure

The following are the main requirements a borrower must meet in order to be approved for a deed in lieu of foreclosure:

  • A deed in lieu has to be a voluntary agreement for the borrower and the lender party involved
    • The borrower are required to request a deed in lieu of foreclosure  in writing stating they are voluntarily asking to open a line of negotiations for a deed in lieu of foreclosure.
    • The writing acts as evidence for the lender in the case the borrower takes them to court and tries to suggest the lender created a state of duress or unneeded pressure for them to turn in the keys to their home as a deed in lieu of foreclosure.  This falls under the parole evidence rule.
  • Both parties have to enter into the agreement in good faith
  • A borrower cannot or cannot appear to have the ability to pay for a deficiency judgment or the lender will most likely not approve a deed in lieu. 
  • A borrower is not allowed to have any junior liens on the property. 
    • A junior lien is a lien that does not have seniority on the property; some professionals would say it is not in the first lien position.  The reason it may not have any junior liens on the property is to prevent these lien holders from not collecting their money or the first lien holder owing them money.  If there are junior liens on the property and the borrower is unable to settle them they may be able to convince the lender to pay off the other liens (this is highly not probable).
    • The lender should research any outstanding liens on the property prior to agreeing to a deed in lieu of foreclosure
  • A borrower must have their house on the market listed by a local licensed real estate agent for 30 to 90 days.  The time period depends on your lender and state legislation.
  • Prior to agreeing to a deed in lieu a borrower or lender will have to have the house inspected and appraised
  • A deed in lieu may be negotiated and accepted until five days prior to an auction of the home.
  • The house and/or property being turned over to the lender cannot have a current market value less than the outstanding debt the borrower owes the lender.  If not the lender tries to negotitate with the borrower to subsidize the difference between the current market value of the home and the outstanding debt.
  • The borrower will have to submit the same paperwork of their financial situation as we discussed in our loan modification section of our website
  • The borrower will have to write a hardship letter.

To conclude a deed in lieu of foreclosure can be a positive outcome if you are in a financial struggle.  However, by walking away from your home you may walk away from a potentially selling your home, you lose the money you put into the house (your equity), and the bank usually only accepts a deed in lieu if it is financially favorable for them.  In the past if there was a debt forgiven the borrower would have to pay income tax, however, the Obama administration made an exception for short sale which leads us to believe that deed in lieu fall under these terms.  If you have no way of fighting your foreclosure or think you could sell your home in the time period your home is being foreclosed upon then a deed in lieu is a great option.

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