Losing a home to foreclosure is devastating, no matter the circumstances. To avoid the actual foreclosure process, the homeowner may opt to use a deed in lieu of foreclosure, also known as a mortgage release. In simplest terms, a deed in lieu of foreclosure is a document transferring the title of a home from the homeowner to the mortgage lender. The lender is basically taking back the property. While similar to a short sale, a deed in lieu of foreclosure is a different transaction.
Short Sales vs. Deed in Lieu of Foreclosure
If a homeowner sells their property to another party for less than the amount of their mortgage, that is known as a short sale. Their lender has previously agreed to accept this amount and then releases the homeowner’s mortgage lien. However, in some states the lender can pursue the homeowner for the deficiency, or the difference between the short sale price and the amount owed on the mortgage. If the mortgage was $200,000 and the short sale price was $175,000, the deficiency is $25,000. The homeowner avoids responsibility for the deficiency by ensuring that the agreement with the lender waives their deficiency rights.
With a deed in lieu of foreclosure, the homeowner voluntarily transfers the title to the lender, and the lender releases the mortgage lien. There’s another key provision to a deed in lieu of foreclosure: The homeowner and the lender must act in good faith and the homeowner is acting voluntarily. For that reason, the homeowner must offer in writing that they enter such negotiations voluntarily. Without such a statement, the lender cannot consider a deed in lieu of foreclosure.
When considering whether a short sale or deed in lieu of foreclosure is the best way to proceed, keep in mind that a short sale only occurs if you can sell the property, and your lender approves the transaction. That’s not required for a deed in lieu of foreclosure. A short sale is usually going to take a lot more time than a deed in lieu of foreclosure, although lenders often prefer the former to the latter.
Documents Needed for Deed in Lieu of Foreclosure
A homeowner can’t simply show up at the lender’s office with a deed in lieu form and complete the transaction. First, they must contact the lender and ask for an application for loss mitigation. This is a form also used in a short sale. After filling out this form, the homeowner must submit required documentation, which may include:
· Bank statements
· Monthly income and expenses
· Proof of income
· Tax returns
The homeowner may also need to fill out a hardship affidavit. If the lender approves the application, it will send the homeowner a deed transferring ownership of the dwelling, as well as an estoppel affidavit. The latter is a document setting out the deed in lieu of foreclosure’s terms, which includes maintaining the property and turning it over in good condition. Read this document carefully, as it will address whether the deed in lieu completely satisfies the mortgage or if the lender can pursue any deficiency. If the deficiency provision exists, discuss this with the lender before signing and returning the affidavit. If the lender agrees to waive the deficiency, make sure you get this information in writing.
Quitclaim Deed and Deed in Lieu of Foreclosure
When the entire deed in lieu of foreclosure process with the lender is over, the homeowner may transfer title by use of a quitclaim deed. A quitclaim deed is a simple document used to transfer title from a seller to a purchaser without making any specific claims or offering any protections, such as title warranties. The lender has already done their due diligence, so such protections are not necessary. With a quitclaim deed, the homeowner is simply making the transfer.
Why do you have to submit so much documentation when in the end you are giving the lender a quitclaim deed? Why not just give the lender a quitclaim deed at the beginning? You give up your property with the quitclaim deed, but you would still have your mortgage obligation. The lender must release you from the mortgage, which a simple quitclaim deed does not do.
Why a Lender May Not Accept a Deed in Lieu of Foreclosure
Usually, acceptance of a deed in lieu of foreclosure is preferable to a lender versus going through the entire foreclosure process. There are circumstances, however, in which a lender is unlikely to accept a deed in lieu of foreclosure and the homeowner should be aware of them before contacting the lender to arrange a deed in lieu. Before accepting a deed in lieu, the lender may require the homeowner to put the house on the market. A lender may not consider a deed in lieu of foreclosure unless the property was listed for at least two to three months. The lender may need proof that the home is for sale, so hire a real estate agent and provide the lender with a copy of the listing.
If the house does not sell within a reasonable time, then the deed in lieu of foreclosure is considered by the lender. The homeowner must prove that the house was listed and that it didn’t sell, or that the property cannot sell for the owed amount at a fair market value. If the homeowner owes $300,000 on the house, for example, but its current market value is just $275,000, it cannot sell for the owed amount.
If the home has any sort of lien on it, such as a second or third mortgage – including a home equity loan or home equity line of credit -, tax lien, mechanic’s lien or court judgement, it’s unlikely the lender will accept a deed in lieu of foreclosure. That’s because it will cause the lender considerable time and expense to clear the liens and obtain a clear title to the property.
Reasons to Consider a Deed in Lieu of Foreclosure
For many people, using a deed in lieu of foreclosure has certain advantages. The homeowner – and the lender -avoid the costly and time-consuming foreclosure process. The borrower and the lender agree to the terms on which the homeowner leaves the dwelling, so there is no one showing up at the door with an eviction notice. Depending on the jurisdiction, a deed in lieu of foreclosure may keep the information out of the public eye, saving the homeowner embarrassment. The homeowner may also work out an arrangement with the lender to rent the property for a specified time rather than move immediately.
For many borrowers, the biggest advantage of a deed in lieu of foreclosure is simply getting out from under a home that they can’t afford without wasting time – and money – on other options.
How a Deed in Lieu of Foreclosure Affects the Homeowner
While avoiding foreclosure via a deed in lieu may seem like a good option for some struggling homeowners, there are also drawbacks. That’s why it’s wise idea to consult a lawyer before taking such a step. For example, a deed in lieu of foreclosure may affect your credit rating almost as much as an actual foreclosure. While the credit rating drop is severe when using deed in lieu of foreclosure, it is not quite as bad as foreclosure itself. A deed in lieu of foreclosure also prevents you from obtaining another mortgage and purchasing another home for an average of four years, although that is three years shorter than the typical seven years it may take to get a new mortgage after a foreclosure. On the other hand, if you go the short sale route rather than a deed in lieu, you can usually qualify for a mortgage in two years.