What is a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure can help homeowners in financial difficulty get out of mortgage debt and keep a foreclosure off their credit report. A deed in lieu of foreclosure is not appropriate for every potential mortgage loan default and must have the cooperation of the lender. The following information explains how a deed in lieu of foreclosure works, its advantages and important items to be aware of.

Deed in Lieu of Foreclosure Defined

If a homeowner with a mortgage is no longer able to make payments and unable to get refinancing to lower monthly payments, there are several options for the lender: loan modification, short sale, foreclosure and deed in lieu of foreclosure.

In the last option, the homeowner requests and receives permission from the lender to sign the deed of the home over to the lender. The lender accepts the deed, absolves the debt and waives, in writing, any right to seek additional money from the homeowner if the sale of the home doesn't cover the loan.

Better Than Foreclosure

In most cases, a deed in lieu of foreclosure is better than foreclosure for the borrower and the lender. The borrower gets out of debt that he cannot afford to pay and avoids foreclosure. Even the borrower's neighborhood benefits as news of foreclosures, which are public record, lower surrounding home values. For the lender, a deed in lieu of foreclosure avoids the hefty costs of foreclosure proceedings and gets the same result, namely that the home is sold for current market value.

Different From a Short Sale

In a short sale, a homeowner, with the lender's permission, puts the home on the market, usually by listing it with a real estate agent; sells it; and then applies the proceeds against the outstanding mortgage balance. The homeowner may still be liable for the loan amount not covered by the short sale. Typically, the lender will forgive the shortage amount, if it is less than the cost of foreclosure.

Important Points to Know

While a deed in lieu of foreclosure can help relieve an immediate threat of default or foreclosure, a homeowner considering it should be aware of the following points:

    * You must approach the lender and the lender must agree. Even if it is a good option, a lender cannot approach a homeowner about giving up a home.
       
    * Your equity is lost. Lenders are most likely to accept a deed in lieu of foreclosure when there is equity. In a foreclosure, you remain the owner of your equity if there is value left over after the loan is paid. In a deed in lieu of foreclosure, it all goes to the lender.
       
    * There could be tax consequences. If the sale of the home does not cover the loan balance, you are being forgiven that amount. If the home is not your primary residence or the forgiven balance is above set amounts, you might face taxes on it.
       
    * Your credit history is affected. A short sale does not affect your credit standing. It is simply a sale of the home. And while a deed in lieu of foreclosure is not as big a black mark on your credit report as a foreclosure, it is still reported and still a part of your credit score calculations.