Information on a deed in lieu of foreclosure.
Another option to consider is a deed in lieu of foreclosure. It can offer a homeowner way out of their financial hardship without going through the lengthy and damaging foreclosure process. While not suitable for everyone (as of course there are pros and cons), this legal agreement is an alternative for people who cannot keep up with their mortgage payments and have tried other solutions. Find details below on what a deed in lieu (DIL) of foreclosure is, its pros and cons, and other important factors.
What is a deed in lieu (DIL) of foreclosure?
This is when the homeowner voluntarily signs a legal agreement that will give the home or property back to the bank, lender, or the party who holds the mortgage. In effect the homeowner voluntarily transfers ownership of their property to the mortgage lender in order to satisfy a defaulted loan and avoid foreclosure proceedings. Essentially, the homeowner signs over the deed (title) to the lender. The process, as also covered on Investopeida here (https://www.investopedia.com/terms/d/deed_in_lieu_of_foreclosure.asp) requires lender approval and is generally used when other loss mitigation options, such as loan modification, refinancing, HUD counseling services or a short sale have failed or aren’t feasible.
While some people may ask, why would I ever do this, the fact is that there are some reasons to consider this option. When all else fails, this is often an approach to consider when the homeowner just can’t pay the mortgage anymore. It is often better to do this then go through a formal foreclosure proceeding in which the family may lose their home anyway.
As a result of the deed in lieu program, in return, the lender typically agrees to release the borrower from any further obligations under the mortgage. However in some cases the bank may rent the property back to the family as part of the deed in lieu of foreclosure process. But note in most cases the lender or bank that repossesses the home will proceed to sell the property in order to pay off the loan.
Pros of a deed in lieu of foreclosure
There are additional benefits for both the lender and the homeowner. The number one advantage to the borrower is that it will release them from most or all of the financial obligations that they may have on the existing loan. A Deed in Lieu of Foreclosure will help the homeowner avoid the public and often drawn-out foreclosure process, which can be stressful, costly, and humiliating. Foreclosure can take months or years, and during that time, homeowners often remain in limbo. So by going down this path it will resolve their personal indebtedness that is associated with the defaulted loan.
In many cases, the lender agrees to forgive any remaining unpaid or delinquent loan balance on the mortgage after the property is surrendered. However, this depends on whether the DIL is executed with a full release of liability. This is why it is recommended to have a lawyer, even a free pro-bono attorney near you, review the legal agreement and deed first. Everything should always be confirmed in writing.
A DIL will usually result in the borrower receiving more generous terms from the court system as well as the lender than they would in a formal foreclosure filing as the approach is much less combative. It benefits the lender too as some of the biggest advantages of a bank is that they will have revolve around the reduction of risk and associated expenses that they will experience.
In addition, another pro of a deed in lieu of foreclosure is that the borrowers credit ratings and scores will be hurt much less than it would if the person were to lose the home to an official foreclosure procedure. See below. This will help them avoid long term hardships, as it can be difficult to get back on track when someone has a poor credit score.
Last, but not least, another advantage is that, unlike in the short sale situation, you do not need to take responsibility, and incur the stress and expense, for selling your house as the lender will do this.
Cons of a deed in lieu of foreclosure
Your lender / bank takes over your home and you lose it. This might seem obvious, but surrendering the property means the end of your homeownership. While some lenders may allow the owner to rent the property (at least for a period of time), if you’re emotionally attached or holding out hope to remain in your home, a DIL can be hard to accept.
Some lenders may try to pursue any balance that was due on your mortgage. This is why, as noted below, it is important to ensure the Deed in Lieu forgives any loan balance. As noted, a legal aid attorney or even free HUD counselor can help with that process. As if the property is worth less than the amount owned on the mortgage and the lender doesn't explicitly forgive the remaining debt, the borrower may still be responsible for the deficiency unless otherwise negotiated as noted.
Lenders are not obligated to offer or accept a DIL. To qualify, you often need to show that you’ve made a good-faith effort to get back on track with the payments or even to sell the home (for example, listing it for a certain period of time). Banks may want to see that you did everything possible to avoid a foreclosure. Also note the property must have a clear title with no junior liens (such as second mortgages or tax liens). Many banks and lenders are offering this option to homeowners. Read more Citi Deed in Lieu of foreclosure program.
What is the DIL impact to my credit rating?
This is more complicated - as there are both pros and cons for the homeowner. While a deed in lieu of foreclosure can lower your credit score significantly (often by 100 to 150 points) but usually not as much as a foreclosure. The exact impact depends on your overall credit profile and history. While the impact to your credit score is much less than if you were to go through the entire foreclosure process and lose your home from that, it is still better to go down 100 or so points vs. a long, drawn out foreclosure which can be multiple of that.
No matter the result, a DIL credit impact is more long term. The negative mark remains on your FICO credit reports will stay for up to 7 years, similar to a foreclosure or short sale. However, credit recovery may be faster with a Deed in Lieu of foreclosure, particularly if your other accounts are in good standing and you avoid further delinquencies.
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