Deed in Lieu of ForeclosureLearn what a deed in lieu of foreclosure is and how it can help you
If you are unable to pay your mortgage, you may be able to qualify for what is called a “deed in lieu of foreclosure.” A deed in lieu of foreclosure (DIL) is a legal procedure in which you willingly transfer the title (deed) of your property back to the lender, and in return the lender agrees to release you from all legal obligations to the mortgage contract. This is often done to satisfy a defaulted loan and to prevent foreclosure proceedings.
A deed in lieu of foreclosure is often better than just walking away from your home, and letting it fall into foreclosure because it has a less detrimental effect on your credit score. You can also negotiate with your lender so that they will not legally come after you to collect any money you may owe on the mortgage in back payments and fees after the lender has sold the property. On the other hand, a deed in lieu is also beneficial for the lender because it avoids the costs and effort required for a foreclosure sale.
How do I get a deed in lieu of foreclosure from my lender?
In general, a deed is a right granted by a legal contract based upon mutual agreement; therefore, a deed-in-lieu must be based upon voluntary agreement in good faith. To proceed with a deed in lieu both parties must agree to and sign both an Agreement in Lieu of Foreclosure, which outlines the terms of the deed, as well as the deed itself, which transfers legal ownership of the property.
In order for the agreement to be reached, the appraised market value of the property must be less than the outstanding debt from the original agreement, and the property must not be subject to any 3rd party creditor claims or liens. A third party escrow service then executes the legal agreement which will release both you and the lender from the original contract.
Once the agreements are reached, and there a clear title, the lender then classifies the original loan as paid and issues a waiver to deficiency judgment, which would normally go into effect in case the sale of the property results in an amount less than what is owed on the debt.
Please be advised that many lenders may not be amenable to a deed in lieu because they believe that they will have a better title after a standard foreclosure sale. This is because a trustee’s deed of sale after a foreclosure effectively erases any judgment liens, and second and third mortgages. Thus, it would depend on the borrower’s lender whether they will accept a deed in lieu or not.
How will a deed in lieu affect my credit?
A deed in lieu of foreclosure can make a negative impact on credit score. An individual may lose 250 or so points with this. The credit report will reflect the deed in lieu for seven years, although a borrower can still rebuild his or her credit. However, the ill effect on the credit score gradually lessens in time. An individual may request its removal from a credit report towards the closing of year seven.
When can I buy a home after a deed in lieu?
Lenders will not offer a loan to an individual associated with a deed in lieu a mortgage for a minimum of two to three years, since the deed in lieu significantly brings down your credit score. The chances of loan approval increase after a few years, especially if a borrower attempts to rebuild his or her credit score. After a few years, it is likely that an individual who has tried to increase his or her credit rating can purchase a home once more.
Please be aware that if you are able to complete a deed in lieu of foreclosure, will may still be liable for taxation on the cancellation of indebtedness or COD income. The tax results would be based on whether the loan is classified as a non-recourse loan or a recourse loan. This classification is specified in the loan documents that were originally signed by the lender and borrower.
Basically, if the only option of the lender is to get back the property when the borrower defaults, then it is a non-recourse loan. However, if the lender can go after the borrower to collect any shortfall when the property is sold, then it is a recourse loan. A lender has to submit a Form 1099-C to the IRS in the case of a shortfall in a recourse loan where a deed in lieu has been granted.
This is known as the borrower’s COD income. In the case of a non-recourse loan, the IRS will consider the tax consequences of the deed in lieu as if the borrower had sold the property. It the current market value of the property is less than what is owed, the borrower will have a personal loss but this is not tax deductible.
On the other hand, if the value of the property is greater than the outstanding loan, the borrower will have a gain that may not be taxed if he is able to comply with IRC Sec. 121 two-year residency requirement. In the case of a recourse loan, the situation is similar to the non-recourse loan except that the borrower will also be taxed for COD income if the value of the property is less than what is owed. Ordinary income rates will be applied for the COD income.
By Moe Bedard
Founder at LoanSafe.org
My name is Maurice “Moe” Bedard. I am the founder of America’s #1 Mortgage Forum, LoanSafe.org. My online work has been featured in the New York Times, LA Times, Fox Business, and many other media publications. I currently live in Carlsbad, California with my beautiful wife and children.
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