What is a Deed in Lieu of Foreclosure?: Getting Back on Track

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A deed in lieu of foreclosure—sometimes called a deed in lieu—is an alternative to foreclosure that may be helpful in certain situations. In a deed in lieu agreement, you transfer the title to your property to the lender in exchange for a cancellation of your mortgage debt. While both foreclosure and deeds in lieu require you to leave your home, a deed in lieu agreement can help you avoid some of the consequences of foreclosure and begin a faster financial recovery.

What is a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure is a transfer of your home to the lender as a way to satisfy mortgage debt that's in default. Choosing a deed in lieu over a foreclosure can help you obtain better terms from your lender and reduce the negative impact on your credit score. The deed in lieu process also moves more quickly than a foreclosure or short sale. Once you have agreed to terms, you will likely have 30 to 60 days to vacate and surrender possession of your home.

In order to start the process, you will need a loss mitigation package from your mortgage lender. The application will need to be filled out and submitted along with documentation detailing your income and expenses. In addition to the application, your lender may require you to meet the following conditions:

  • You must have tried to sell your home
  • There can be no additional liens on your home other than your mortgage
  • The lender cannot have started the foreclosure process
  • You and your lender must agree on terms that include the fair market value of the home

The Consequences of a Deed in Lieu

The most obvious and significant consequence of a deed in lieu is the loss of your home. Unfortunately, this is an inevitable result whether you choose to pursue a deed in lieu or accept foreclosure. The main benefit of obtaining a deed in lieu agreement is that you'll stop incurring additional interest or late fees on the money you borrowed. However, you may still owe money if your property's resale value doesn't cover your outstanding mortgage balance.

When your property is transferred to the lender via a deed in lieu agreement, you can still be held responsible for making up any deficiency between the property's resale price and the amount you owe the lender. The lender may choose to pursue collection activities against you if you fail to repay the deficiency.

The lender can choose to forgive the difference, but that isn’t a wholly beneficial scenario. If the deficiency is greater than $600, the lender must file a 1099C form with the Internal Revenue Service (IRS), letting the agency know how much money was forgiven. That amount then counts as part of your taxable income for the current year.

Beyond the negative tax implications, the long-term effect of a deed in lieu includes a significant hit to your credit score. A deed in lieu agreement is not as severe as the impact of a foreclosure, but having it in your credit history may make future financing more difficult to obtain.

Deed in Lieu vs Short Sale: Which Should You Choose?

While both deed in lieu agreements and short sales represent alternatives to foreclosure, neither will spare you from a lower credit score, the possibility of a deficiency judgment, or an increase in your taxes. Choosing the option that works best for you will depend on the terms your lender offers for each and how quickly you can be out of your home.

A short sale occurs when your lender agrees to let you sell your home for less than the amount you owe on your mortgage. You put the property up for sale on the market and negotiate a price that must be approved by the lender. The lender may also impose additional conditions requiring that you agree to submit to a deficiency judgment or sign a note for the deficient amount.

Short sales are generally the more popular alternative to foreclosure, and lenders are somewhat more likely to approve a short sale than a deed in lieu agreement. A short sale is generally more appealing to a lender because the homeowner is responsible for testing the market and putting in the work to sell the home. The lender is also able to define the terms of the sale and remains free to proceed with a foreclosure if those terms aren't met.

Compared to short sales, the major advantage of a deed in lieu agreement is a speedier process. Short sales can take a year or more to complete after the lender agrees on terms, while a deed in lieu can be completed in a month or two. In addition, a deed in lieu doesn't require you to go through the effort of selling your home. This would include arranging for showings and working with real estate agents and buyers to negotiate a lender-approved deal.

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