No one wants to lose their home, but life gets in the way of our best-laid plans. Sometimes things happen that are beyond our control. If you find yourself falling behind on your mortgage payments, you could be at serious risk of foreclosure. This can be an incredibly long process that’s painful both financially and emotionally.
In certain instances, a deed in lieu of foreclosure may be a better option than putting yourself through the process of being foreclosed upon. We’ll explain what a deed in lieu of foreclosure is, the advantages and consequences, how it works and how to evaluate whether one is right for you.
What Is A Deed In Lieu Of Foreclosure?
A deed in lieu of foreclosure is a document that voluntarily transfers the property’s title from the homeowner to the mortgage lender in exchange for a release from the mortgage obligation.
If you’re facing foreclosure, a deed in lieu can protect you from a formal foreclosure process, but there are still significant consequences for your credit and your prospects for getting a mortgage in the near future. For this reason, you should look at all other options and only use a deed in lieu of foreclosure as a last resort.
When Should You Consider A Deed In Lieu Of Foreclosure?
Before working at a deed in lieu of foreclosure, you should consider two other options that have less impact on your credit and future mortgage prospects: a loan modification or a short sale.
The first thing to take a look at is a loan modification. These can be permanent or temporary. If your financial situation is temporary, you may be able to work out a repayment plan with your lender or go into temporary forbearance before fully paying off the debts when you get back on your feet. If your issue is more long-term or permanent, you may have to talk to them about a type of modification involving forgiving a portion of the mortgage balance, lowering the interest rate or lengthening the term.
Be aware of the type of modification you’re getting because some will have requirements that make sure your payment is reported as being made on time and in full. Others will report a debt settlement, which will hurt your credit score, though not as negatively as some other options.
If you’re trying to get a conventional loan after having a modification in the past, Fannie Mae and Freddie Mac will evaluate your entire credit history in order to determine whether, on balance, you’ll be a good credit risk. The FHA, USDA and VA don’t have any specific timelines, but they will look at the number of late payments you have and factor that into the decision. If you’re getting a jumbo loan, you could have to wait up to 7 years, but this isn’t always the case. Meanwhile, some lenders may offer special programs to help clients in this situation, so talk to a Home Loan Expert.
Short sales occur when a homeowner works with a lender to execute a managed sale of the property for less than the balance owed on the mortgage. The lender typically covers closing costs. This may be an option if a loan modification wasn’t possible.
You will take a major credit score hit from this. This could drop your credit score by as much as 130 points, depending on your starting score before the sale and the model being used.
However, the real advantage of a short sale comes in terms of your short-term mortgage prospects. It’s possible to get an FHA mortgage immediately if both of the following are true and you otherwise qualify based on credit requirements:
- You have no mortgage or installment payments reported as 30 days or more late in the 12 months leading up to the short sale date.
- No mortgage or installment payments of 30 days or more late in the year prior to application.
Assuming your credit is back in shape, those eligible for a VA loan may be able to get a new loan within 2 years of a short sale. You may be able to get a USDA loan after waiting 3 years, and a conventional loan has a waiting period of 4 years, while it’s 7 years for jumbo loans.
If neither a loan modification nor short sale is an option, a deed in lieu is the next alternative, but it’s important to be fully educated on the pros and cons before making a decision.
Deed In Lieu Of Foreclosure Advantages
Compared to other options that may be available when the mortgage isn’t salvageable for you, a deed in lieu may be a better option for a variety of reasons:
- There’s less negative impact on your credit score. As with any negative event impacting your credit, the higher your score is before the negative impact, the bigger the drop will be. With a deed in lieu of foreclosure, the drop might be anywhere from 50 to 125 points or higher. With a foreclosure, the drop is anywhere from 85 to more than 160 points. Additionally, in certain circumstances, you may be able to get a mortgage sooner. The waiting period on a conventional loan after a deed in lieu is 4 years compared to 7 years on a conventional loan.
- There’s less publicity to a deed in lieu. Foreclosures come with a public notice of foreclosure proceedings on your door. Some people prefer to give the property to the bank rather than endure what they perceive to be an embarrassing process.
- You may be able to avoid further financial loss. With a foreclosure, depending on state law, the lender may have the right to go after you for the difference between the lender’s proceeds from the sale and the amount you still owe on the balance. If you willingly turn the property over in a deed in lieu or short sale, the lender or mortgage investor may be more willing to waive the remaining debt.
- You could get cash to help move. Sometimes a lender will give you money to help incentivize you to keep the property up until the sale and to find a new living arrangement. How much they would be willing to give you may depend on your history of past due payments and any built-up equity. You’re also not likely to get as much money from the bank as you would if you were to just sell the property on the open market.
Deed In Lieu Of Foreclosure Consequences
A deed in lieu of foreclosure should still be avoided whenever possible due to having several negative impacts, some of which can be long-lasting.
- A deed in lieu still damages your credit quite a bit. The potential for a 125-point drop in your credit score or higher isn’t something to be taken lightly.
- You’ll be unable to purchase another home for several years. As mentioned above, there’s a 4-year waiting period for getting a conventional loan. The FHA, USDA and VA treat a deed in lieu the same way they would a foreclosure. The waiting period for a USDA or FHA loan is 3 years, while it’s 2 years if you qualify for a VA loan. Some lenders may have loan options that allow you to get into a home sooner, so speak with a Home Loan Expert.
- You lose any existing equity in the property. Your lender is under no obligation to pay you for any existing stake you might have built up over the years.
- You could end up with a deficiency judgement. Although the mortgage lender or investor may waive the difference between the proceeds they get from the sale and the balance you owe, they’re not obligated to do so. You could end up with a judgement for the difference.
- You might face tax liability. In certain circumstances, debt which is forgiven by a mortgage investor or lender is considered taxable income. Speak with a tax advisor if you’re unsure how to proceed.
Steps In The Deed In Lieu Of Foreclosure Process
If a deed in lieu of foreclosure is a possibility for you, you should know what to expect. Here are the steps in the process:
- Call your mortgage company to explain the situation and start the process.
- Gather your basic financial documents: mortgage statements, bank statements, pay stubs.
- Fill out a deed in lieu of foreclosure form and provide any documentation requested.
Getting a deed in lieu is a legal process and having a real estate lawyer help you may be a good idea. They’ll have an understanding of the provisions of the agreement and what you will and won’t be responsible for. Having someone negotiate on your behalf could save you money above and beyond whatever legal fee is necessary.
Does A Lender Have To Accept A Deed In Lieu Of Foreclosure?
There can be many cases in which accepting a deed in lieu is advantageous for a lender, but they are not obligated to accept a deed in lieu from you. There are many reasons they might not choose to move forward with it.
Depreciated value of the home or liens or judgments which make it more difficult to sell the property and get the appropriate amount of proceeds back for the lender after being split between the affected parties would be a reason for rejection. They’re also less likely to accept this if there is a belief that the property is in rough shape.
In other instances, the servicer that collects your payment for the lender may not allow a deed in lieu, or the mortgage contract may prevent it. Make sure to fully understand all of your options.
Is A Deed In Lieu Of Foreclosure Right For You?
A deed in lieu of foreclosure involves signing a property over to the lender rather than going through a formal foreclosure process. If you can’t get a short sale or a loan modification approved, this may be the next best option. With that said, there’s still a significant credit impact, though not as bad as a normal foreclosure. It’ll also be several years before you can get a mortgage again in many cases, although lenders may have an option for you, so don’t hesitate to speak with a Home Loan Expert. Finally, a lender won’t always accept a deed in lieu of foreclosure, particularly if there are things like other existing liens.
A deed in lieu of foreclosure should always be a last resort after you’ve exhausted every other avenue. If you’re a Quicken Loans® client who’s having mortgage payment trouble, please contact us at (800) 508-0944 to go over any options you may have for assistance. We’re here to help.