Rather than have your home foreclosed, a deed in lieu of foreclosure can mitigate damage to your credit score and hopefully wipe the slate clean.
What Is a Deed In Lieu?
Lieu is a Latin word meaning instead of.
In foreclosure terms, instead of the bank foreclosing your home, you sign the property deeds over to the mortgage company. In return, the mortgage company cancels any outstanding debts so you are relieved of further financial obligations.
The deed in lieu option is a last resort you take only when you’ve fully explored all other avenues to prevent foreclosure of your home.
What is the Process of a Deed In Lieu?
If you have been unable to sell your property, you can approach your lender to see if they will consider a deed in lieu. You will normally be required to show that you’ve made some effort to sell the home first.
If your lender agrees to a deed in lieu, you will sign a document that transfers the title from you to the lender. This is then notarized by a public notary and registered at the local land registry.
Benefits Of A Deed In Lieu
With a deed of foreclosure, you voluntarily give up your home to the lender rather than pursue foreclosure through the court.
In the long term, this is a better solution because:
- It avoids lengthy and costly legal proceedings
- It costs less for both the borrower and the lender
- It’s more discreet. A deed in lieu agreement is made in private between the lender and the borrower so it prevents the embarrassment of eviction proceedings
- You avoid having an eviction notice on your file
- You may have the opportunity of renting the property for a while after the transaction
- A deed in lieu takes around 90 days while a foreclosure can take between 6 and 12 months so you can start to repair your credit score sooner
The idea of the deed in lieu is that you are freed of any financial and legal obligation when you sign over. That said if the value of the house is lower than the amount you owe then the bank will pursue payment of the remaining balance. This is called a deficiency judgment.
To avoid a deficiency judgment, you should consult an attorney for advice on how to get a written waiver. Ideally, if you’re handing back your home, you’ll want to walk away free from any further debt.
Note that if the deficiency is waived, you will be liable to pay tax on the amount waived.
How Does a Deed In Lieu Affect Your Credit Score?
There seems to be a common assumption that a deed in lieu has less impact on your credit score than a foreclosure.
However, research by the credit scoring organization FICO suggests otherwise. If your home is foreclosed, it leaves a mark on your credit file for seven years. A deed in lieu or short sale has the same impact on your credit score.
FICO’s research from 2011 shows that the higher your credit score, the more it will drop as a result of a deed in lieu of foreclosure (1). It can also take longer for your credit score to recover if your credit score is high.
Analysts from FICO compared the effects of delinquencies on credit scores in a sample of borrowers. The analysis found that someone with a credit score of 680 would drop between 50 and 70 points after a deed in lieu or short sale.
Interestingly, a starting credit score of 780 can drop from 105 to 125 points. It can also take longer to recover if you have a high credit score. Someone with 680 will recover in 3 years, but someone with a score of 780 can take around 7 years.
Although your credit might look the same on paper, if you apply for a mortgage again a lender is likely to look more favorably at a deed in lieu than a foreclosure as it is voluntary (2).
Deed In Lieu of a Rental Property
It would be wise to seek legal advice from a foreclosure attorney about carrying out a deed in lieu if your property is rented out.
Tenants in the US are protected by the Protecting Tenants by Foreclosure Act (2009) (3). Lenders must give a tenant at least 90 days to find a new home or the length of the lease, whichever is longer. But, if the new owner wishes to move into the property, tenants have 90 days to vacate the property.
Once a deed in lieu is complete, the new owner is now the landlord and responsible for the tenant.
A foreclosure attorney will be able to advise you if your tenants are covered by the act in the case of deed in lieu.
If you’re renting, and your tenancy is terminated due to a deed in lieu you may want to check that it’s not showing up on your credit report (4) later on. If it is, you’ll need to get this removed by presenting your tenancy agreement and eviction notice to the credit agency and requesting its removal.
Can I Be Refused a Deed In Lieu?
The answer is, “Yes.”
If there is a junior lien, i.e. a second mortgage taken out as collateral, a lender is likely to refuse a deed in lieu. This depends on the lender and the situation, but lenders prefer it when only the original loan is in place.
For a deed in lieu to be profitable to a bank, the debt needs to be worth more than the property. If your equity is more than the debt, your bank will refuse a deed in lieu.
- While a deed in lieu will leave a mark on your credit score, it will be no better or worse than a foreclosure or short sale
- You can walk away from the whole debt and start afresh after a deed in lieu is complete as long as you avoid a deficiency judgment
- Deed in lieu is quicker, less stressful, and cheaper than the foreclosure process