Basics of a Deed in Lieu of Foreclosure

An alternative to foreclosure can be a deed in lieu of foreclosure.

Are you behind on your mortgage payments and considering just letting your house go in a foreclosure? Have you been getting collection calls and feel like it’s time to give up? When you feel like you have no options, it’s tempting to do nothing and just accept the inevitable.

But before you give up, you need to know that you do have options to avoid a foreclosure. You should learn what those options are, and how those options can work for you. One option is for you to complete a deed in lieu of foreclosure.

What Exactly Is Foreclosure?

In a foreclosure, your lender is essentially calling your loan due and telling you that it can take your house because you have defaulted. Remember that huge stack of papers you signed when you purchased your home? In that pile was a mortgage (or deed of trust) that you signed giving the lender a security interest in your home. This means that in the event of a default—like if you stop making your monthly payments—the lender has the right to foreclose. Foreclosure is the legal term for the process your lender goes through to take and sell your house to recover the money it loaned you.

Deed in Lieu of Foreclosure

A deed in lieu of foreclosure is an alternative to foreclosure that has been around for years. It is a negotiated settlement between you and your lender in which you voluntarily relinquish title to your house, and your lender agrees to stop the foreclosure. (Learn the steps to completing a deed in lieu of foreclosure.)

A deed in lieu of foreclosure can benefit both you and your lender; it saves your lender from foreclosure costs, and you won't have a foreclosure on your financial history. (Learn more about the deed in lieu of foreclosure process.)

Though, be aware that a deed in lieu of foreclosure will still significantly hurt your credit score.

Avoiding a Deficiency Judgment

In some states, lenders have the right to sue borrowers for deficiencies after a foreclosure or a deed in lieu of foreclosure.

A deficiency is the difference between the amount you owe on your mortgage loan and the price your lender gets for your home when it sells at a foreclosure sale. In other words, if you owe your mortgage lender $300,000 on your house and you default, and the foreclosure sale brings in just $250,000, the deficiency is $50,000. If permitted by state law, the lender can sue you for the $50,000 and get a deficiency judgment—even though it already took the house.

With a deed in lieu of foreclosure, the deficiency is the difference between the total debt and the fair market value of the house.

As part of the deed in lieu of foreclosure negotiations, you should get your lender to agree to release you from having to repay any deficiency, perhaps in exchange for your agreeing to deliver the house to your lender in good condition. Make sure to get the deficiency waiver in writing. Though, if the lender forgives all or part of the deficiency, you could face tax consequences.

Know Your Options

If you are a distressed homeowner who's facing a foreclosure, knowing your options is very important. As soon as you realize that you're in financial distress, call your servicer's loss mitigation department to find out what alternatives to foreclosure—such as a refinance, loan modification, short sale, or deed in lieu of foreclosure—are available to you. (The servicer is the company that manages your loan account on behalf of the lender. Servicers process borrower payments, manage escrow accounts, and pursue foreclosure for defaulted loans.)

You have nothing to lose by calling the servicer and the call might make a huge difference. You will typically be provided a packet of information and documents to complete. If you don't understand the contents of any of these documents, ask for help, either from an attorney or a free HUD-certified housing counselor.

While the foreclosure process can be scary, you have some choice in the matter. Ask for help. Explore your options. Most of all, stay informed.

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