When financial difficulties make it hard to pay your mortgage, you may worry about the impact a foreclosure could have on your credit. No matter the situation, like a medical emergency, divorce or the loss of a job, you're now in a position where you think foreclosure may be your only choice. Perhaps you've even tried selling your house, but haven't been able to do so.
A deed in lieu of foreclosure could reduce the stress and ongoing repercussions that come with a foreclosure. Let's look at both of these options and review the advantages of working with your lender to negotiate a deed in lieu of foreclosure.
What is foreclosure?
Foreclosure happens when you stop making mortgage payments over a period of time. Depending on your state, the foreclosure process may begin after you've missed a set number of payments. Once the foreclosure is complete your mortgage lender or a third party that bid on the property becomes the owner of the home. If you're still living there, you'll have to leave.
When your home is foreclosed you face a host of issues that can cause ongoing problems, even if you get your immediate financial circumstances straightened out. These include:
- Bad credit. Your foreclosure will be reflected on your credit report for seven years and can make it difficult to buy or rent a home. Many creditors view a foreclosure as being a significant risk and may not lend to you for other types of credit such as an auto loan or credit card.
- Ongoing debt. Many people think that by choosing foreclosure, you're off the hook for all mortgage-related costs and expenses, including back payments. However, depending on the state, your lender may be able to pursue legal action for back payments or expenses. You may also face collection attempts.
- Reduced resources. Even if you regain your financial standing, you may not qualify for many programs that would allow you to buy another home. Your interest rates may be higher than normal, and you could pay significantly more for another home loan.
If you can avoid foreclosure, it may make financial sense to do so. Fortunately, a deed in lieu of foreclosure can help you avoid some of these problems.
What is a deed in lieu of foreclosure?
A deed in lieu of foreclosure allows you to transfer title to your property to your lender in exchange for canceling your mortgage debt. You lose your home and any equity you may have built up, but you may be able to walk away without additional fees or penalties, and without a foreclosure on your record, but your credit may still be affected.
With a deed in lieu of foreclosure, you don't get to keep your home, so it's still a significant loss. It's important to explore every possibility before you decide to pursue this option. Before you move forward with a deed in lieu of foreclosure, look into the following:
- Modifying your mortgage. Many lenders have programs available for mortgage holders who are at risk of defaulting on their mortgage. You may be able to reduce your payments for a little while.
- Getting outside help. There are some programs that can help mortgage holders with specific circumstances, such as job loss in a particular industry. You may qualify for programs that will pay your mortgage for a few months until you recover financially. Talk to your lender or local housing nonprofit organization.
- Conducting a short sale. This is where your lender allows you to sell your home for less than you owe on your mortgage. Some lenders may forgive the difference between what you owe and what your home sells for, so you can walk away without having to make up the difference. There could be tax implications, so be sure to check with your personal tax advisor.
- Declaring bankruptcy. Filing for Chapter 13 bankruptcy can allow you to make payments on your mortgage after your debts have been reorganized.
If none of these options are right for you, or you cannot make them work in your circumstances, a deed in lieu of foreclosure might be the best action to take.
Advantages of a deed in lieu of foreclosure
For the homeowner, there are several advantages of getting a deed in lieu of foreclosure.
- Your credit may be less damaged. While a deed in lieu of foreclosure may still show on your credit report, it may carry less stigma than an actual foreclosure.
- You won't pay as much or all of any deficiency. If you owe more than your house is worth, that's a deficiency. In many states, you're responsible for paying this deficiency to your lender if they foreclose, along with any interest and penalties that accrue. With a deed in lieu of foreclosure, you may be able to negotiate this deficiency so the terms are more favorable for you, or possibly eliminate it completely. There could be tax implications, so be sure to check with your personal tax advisor.
- You could get some cash. If there isn't a deficiency, the local real estate market is strong and they could come out ahead on the deal, some lenders might offer you a "cash for keys" Arrangement. You could get some money for moving expenses and a new place to live in exchange for vacating the property quickly and leaving it in good condition.
Many lenders will be willing to take these steps to resolve the problem since it can be less hassle and expense for them.
Disadvantages of a deed in lieu of foreclosure
A deed in lieu of foreclosure may not be advisable or even possible if you carry a second or third mortgage. The other lenders would need to agree to the deed, and they may not benefit as much as the lender for your primary mortgage would. Some mortgage servicing agreements may also prevent your ability to get a deed in lieu.
If you do get a deed in lieu, you may end up with a tax burden. Consult your tax advisor before considering this option.
What to expect in the deed in lieu of foreclosure process
If you decide to seek a deed in lieu of foreclosure, here are the typical steps you will take:
- Communicate with your lender. Explain your financial situation and ask if a deed in lieu is an option.
- Consider talking to a real estate attorney. Once you confirm that you can pursue a deed in lieu, you may want to speak with a legal professional to ensure you understand how the deal works and how any deficiency will be handled. Be sure to consider any potential tax consequences.
- Fill out an application for the deed in lieu. This will include providing proof of financial hardship and difficulty making mortgage payments.
- Provide documentation of your monthly income, expenses and assets. This will help prove financial hardship and show that you're unlikely to be able to make payments any time soon which may encourage your lender to agree to the deed.
- Work with your lender to provide additional documentation as needed and answer any questions. This period can take as long as 30 days while your lender considers and processes your application and documentation. You can also get answers to your questions about any deficiency or whether you'll be able to get any cash out of the deal.
- Make arrangements for a new home and prepare your property for move-out. You may need to turn over the home in a certain condition or the deal will be canceled. Ideally, you'll leave the property in suitable shape to go on the market.
Your lender will let you know if there are any other steps to take and advise you on the timeline, which should still be shorter than if you decided on foreclosure.
What happens after deed in lieu of foreclosure
Once the deed is issued, the lender will own your home and you will need to move out immediately unless you've made other arrangements. In some cases, the lender will permit you to lease the property for an additional month or two if you provide a compelling reason for needing to do so.
The deed in lieu will be part of your credit history for a period of time, and may make it difficult to get a new home loan or other type of financing. However, once it's off your credit report, you may be able to qualify for a mortgage. And you won't face additional fees and penalties that can come with a traditional foreclosure.
If you're experiencing financial hardship or want to learn more about qualifying for a mortgage after a deed in lieu of foreclosure, speak to a Home Lending Advisor.