A deed in lieu of foreclosure isone of the options available to homeowners who default on their mortgage.For borrowers at risk of losingtheir home, a deed in lieu of foreclosure can be a better solution than a full foreclosurefor a number of reasons—chief among them the fact that your credit score will take less of a hit. Here’s what to expect when you’re asking a lender to consider this.
What is adeed in lieu of foreclosure?
Homeowners who decide not to put up a fight to keep their home or to stave off foreclosurecan insteadpursue a deed in lieu of foreclosure. It is essentially a legal and binding document that transfers the title from the homeowners to the bank that holds the mortgage.
This process means signing over anylegal right to your home, and handing over both the deed and the keys to the house. In exchange, the lender agrees to immediately release the borrowers from their mortgage obligations. Lenders tend to be open to this option. After all, when a homeowner comes to a bank and says, “take my house, I know I can’t pay,” a lender is saving the costs that come with a traditional foreclosure process.
The same goes for the homeowner. “They give the house back to the lender to avoid the hassle of dealing with the legal process and harm it causes to their credit,” explainsEric Wilson, director of operations at Better Mortgage, an online direct mortgage lender in New York City.
This approach was especiallycommon in the early 2000s,saysJohn Moran, ahome mortgage specialistin Telluride, CO. Banks would often make deed in lieu of foreclosure a more appetizing option by throwing in some cash to sweeten the deal. Often called “cash for keys,” the option allows homeowners to leave the home in good condition and provide the deed in return for a cash payment.
Be aware that some mortgage agreements don’t allow for a deed in lieu of foreclosure.
“Most loan programs have specific guidelines that determine what options a homeowner can pursue when they go into default,” Wilson says.
Advantages of a deed in lieu of foreclosure for borrowers
If your mortgage service has given you the go-aheadfor a deed in lieu of foreclosure, there are some thingsthat will benefit you.
Byadmitting fault from the start, a homeowner essentially stops foreclosure proceedings intheir tracks. The bank doesn’t have to file paperwork, nor does the homeowner have to go through the back-and-forth of whether or not the bank will take the house.
While some homeowners want to delay the process while they scramble to pull together the cash to save their home, opting for the deed in lieu of foreclosure can be a relief, Moran says.
“It also allows them to begin fresh sooner than they might if they were togo throughthe process of a full foreclosure,”he says.“The mental toll on a family waiting to be foreclosed upon is pretty significant, so the deed in lieu gives them some control over the timeline.”
There can be financialadvantages, too. Most homeowners walk away from the mortgage without having to pay the difference between the money owed and the value of the home when the lender sells it, saving them a large chunk of cash. Some banks even provide money directly to the borrower—in the“cash for keys” situation.
And while foreclosure will almost certainly hurt your credit score, a deed in lieu of foreclosure tends to be viewed more favorably by future lenders, Wilson says.
It’s rated on par with a short sale by most creditors who are reviewing a borrower’s ability to purchase a future home.Fannie Mae and Freddie Mac guidelines require just four years from a deed in lieu or short salebefore allowing someone to take out another home loan. If a full foreclosure takes place,aseven-year waiting period is required.
And while short sales require listing a home and trying to find a buyer to get out of foreclosure, the deed in lieu process skips that step. Your bank will have to find a buyer, allowing you to walk away without another headache.
Disadvantages of a deed in lieu of foreclosure for borrowers
Despite all these advantages, adeed in lieu option does not always guarantee you will save money. In some states and situations, the homeowner may be on the hook for the difference between what was owed and what the lender was able to recover when tax season comes around.
There’s also the credit hit to consider. While this route does mitigate the damage to a credit scorethat’s suffered if the bank forecloses, the deed in lieu routestill shows up negatively on a credit report.
Some lenders will report a deficiency (the amount of money they were not able to recoup when the property was eventually sold) as a separate derogatory account on credit, says Moran.
“The impact of the entire situation will depend on how long the loan was in default, when the deed in lieu or short sale took place, and how the lender reported the whole situation to the [credit-reporting] bureaus.”
Experts suggest consultingan attorney and having a conversation with your lender before you offer up a deed in lieu of foreclosure.
