Deed in Lieu
The term deed in lieu is a short phrase commonly used to refer to a deed in lieu of foreclosure, which is a tool that may be used by some homeowners who are seriously behind in their mortgage payments, and seeking a way out. Foreclosure is a costly endeavor for both the homeowner and the financial institution holding the mortgage. There are a few options available to mitigate those costs, of which one is the deed in lieu of foreclosure, which involves signing over ownership of the property to the mortgage holder without going through the foreclosure process. To explore this concept, consider the following deed in lieu definition.
Definition of Deed in Lieu
- The act of giving property back to the lender without foreclosure.
What is a Deed in Lieu of Foreclosure
Home ownership is an expensive proposition, not only in the actual price to purchase the home, but the cost of maintenance and upkeep. It is not uncommon for homeowners to experience unexpected financial difficulties that make it impossible for them to keep up their required payments to the mortgage holder, or “lender.” Lenders often work with homeowners who are delinquent in their payments, helping them create a temporary payment schedule, offering loan modifications, and even making forbearances, in an attempt to bring the loan current, and allow the borrowers to remain in their home.
If a homeowner simply cannot catch up on the payments, or cannot comply with the modifications and other options, the lender has the right to recoup its costs by foreclosing on the property, and selling it. Foreclosure takes time, and it requires the home be sold at auction, where it may not be sold for full market value, making it a costly alternative for everyone. A deed in lieu of foreclosure is an option intended to make the process less time consuming and expensive, as the homeowner voluntarily signs the property’s deed over to the lender. In exchange for being saved the hassle of foreclosure, the lender releases the homeowner from his mortgage obligations.
David and Marian got married and purchased a home in 2007. In 2008, their adjustable rate mortgage skyrocketed, making it very difficult for them to make their mortgage payments. A year later, the couple had a baby, and Marian gave up her job to take care of the baby. David and Marian were drowning in mortgage debt and needed a way out before the situation got any worse.
After talking to the lender, the couple agreed to sign over ownership of the home to the bank, and to move out. This allowed the bank to sell the home to recoup the amount originally loaned on the property. In this example of deed in lieu, David and Marian are released from their loan obligation, and are able to move on with their lives.
Deed in Lieu as Loss Mitigation Option
Loss mitigation refers to the process of minimizing the financial loss of such transactions as home loans in default. The greatest benefit for the homeowner is the prevention of foreclosure, as the loss mitigation option chosen should create a mortgage solution that is financially workable, or which relieves the homeowner of the mortgage responsibility altogether. The primary benefit to the lender is the avoidance of the usually sizeable financial burden incurred in foreclosure.
There are a number of loss mitigation tools available to lenders, including:
- Loan Modification – Encouraged by a federal program, the homeowner is offered new mortgage terms, including a lower interest rate, and often an extended term, which result in lower monthly payments. The goal is to turn a loan in default to a loan earning money for the lender.
- Forbearance – The lender agrees to reduce or defer the receipt of mortgage payments for a specified period of time. This allows the borrower a temporary respite, and is used in times of short-term financial crises, such as a death in the family, or a serious illness or injury preventing the borrower from working for a period of time. The homeowner must resume making payments at the end of the forbearance term, and there may be additional costs.
- Short Sale – An agreement by the lender to accept a payoff amount that is less than the remaining principal of the mortgage loan balance. This may occur when the homeowner owns more on the loan than the property is worth, allowing the homeowner to sell the property at market value.
- Deed in Lieu – The voluntary transfer of title from the homeowner to the mortgage holder in exchange for being released from all mortgage loan obligations.
Pros and Cons of Deeds in Lieu
When a lender accepts a deed in lieu, the borrower’s liability, as well as the liability of any other persons responsible for the debt, is terminated, unless there is an agreement otherwise. Like any other contract, the specific terms and conditions of granting and accepting of a deed in lieu of foreclosure are negotiable.
Advantages to Borrower
- Release from loan liabilities
- Avoidance of expense and publicity of foreclosure
- Lender may pay the expenses of title transfer
- There may be monetary consideration paid back to the borrower/homeowner if there is sufficient equity in the property once sold
- The lender may grant certain property rights back to the borrower, such as a lease, or option to purchase
Sal has been living in his home, and making mortgage payments on it, for 16 years. When Sal becomes unable to work, he falls behind on his mortgage payments, and decides to speak to the lender regarding his options. The lender offers Sal a deed in lieu of foreclosure, in which Sal forfeits any equity that may be in the property at the time of transfer, in exchange for a complete release of liability under the mortgage.
In this example of deed in lieu as an option in loss mitigation, Sal could decide to simply wait out the foreclosure, but it is highly likely that the lender could obtain a deficiency judgment, which would require Sal to pay the amount still owed to the bank after the sale of the property. By accepting the deed in lieu settlement, Sal gets to walk away without that worry.
Disadvantages to Borrower
The core disadvantage of a deed in lieu to a borrower is the loss of the property. Of course, the owner will lose the property if it is foreclosed up on as well, but he will likely suffer additional financial losses in that case. Another disadvantage to the borrower is that transfer of the property to the lender may be taxable.
Advantages to Lender
The advantages of accepting a deed in lieu of foreclosure begin with the lender becoming the owner of the property. This allows the lender to control operation of the property, take advantage of any income generated by the property, and sell the property for the best possible price in order to profit, or to at least minimize loss. A deed in lieu allows the property title to be transferred quickly and easily, allowing the lender to put the property on the market immediately.
In the real estate finance business, time is money – a deed in lieu allows the lender to avoid the time and expense of the foreclosure process. In addition, if there is no equity in the property above the amount owed on the debt, there can be no claim by a bankruptcy court if the borrower later files for bankruptcy.
ABC Mortgage Company lent Mr. Smith $80,000 to purchase his home. Mr. Smith, who lost his job six months ago, has repaid a total of $57,000, and his house is worth 82,000 right now. In this example a deed in lieu of foreclosure would save the mortgage company the costs associated with the legal process of foreclosure, not to mention the fact that, over the next several months that foreclosure will take, the value of the home could decline further.
Disadvantages to Lender
Primary disadvantages to a lender in accepting a deed in lieu are a result of entering into the transaction in sub-optimal conditions. For instance, accepting a partial conveyance (transfer) of the property for forgiveness of only part of the debt may cause title problems, valuation problems, and a host of other potentially costly issues. Likewise, accepting a deed in lieu on a property that has outstanding judgments or subordinate liens is likely to cause problems obtaining clear title. This may occur even if the borrower promises to remove subordinate liens.
These types of problems become disadvantages to the lender, as judgments, subordinate liens, and clouded title, are often largely outside the lender’s control, and sometimes out of the borrower’s control, making resolution time consuming and labor-intensive.
Deed in Lieu Example Form
There is a process the homeowner must go through in negotiating a deed in lieu settlement with the lender. The homeowner/borrower will be required to complete an application, which will help the lender determine whether a deed in lieu is a beneficial option. The information likely to be required on such an application includes:
- Proof of income – usually paystubs for a period of three or more months
- Recent tax returns – usually for the two most current tax years
- Financial statement of monthly income and expenses – an orderly statement of the borrower’s income, and all expenses
- Recent bank statements – usually for a period of three or more months
- Letter or affidavit of hardship – a statement of the present circumstance, which is beyond the borrower’s control, which resulted in the borrower’s default on the loan
Once the lender decides to accept a deed in lieu of foreclosure, a contract must be drawn up and signed by the parties. The following example deed in lieu form provides a sample only. Any deed in lieu of foreclosure form must comply with the real estate laws in the state where the property lies.
Deed in Lieu of Foreclosure
This Deed is made on this _____ day of ______________, 20___, between Grantor [property owner], of [address], and the Grantee [Lender], of [address].
For valuable consideration, the receipt of which is hereby acknowledged, Grantor hereby deeds to Grantee, in lieu of foreclosure, the following described real property:
This Deed is an absolute conveyance. Grantor has sold the above-described real property to Grantee for full satisfaction of all obligations secured by the Deed of Trust heretofore executed by Grantor, and filed with the County Recorder, as Instrument No. ______, Page No. ______, Book __________, on Date ______________.
Grantor hereby declares that this conveyance is freely and fairly made, and that there exist no other agreements, whether oral or written, than this Deed, between the Grantor and Grantee, with respect to the real property described herein.
Executed this _____ day of _________________, 20 ___.
NOTE: Any Deed in Lieu of Foreclosure form must be notarized.
California on Deficiency Judgments Following Deeds in Lieu
Deficiency judgment is an award of the difference between the amount owed on a foreclosed property and the price it ultimately sold for. Lenders who take back properties through foreclosure, short sale, or deeds in lieu of foreclosure have an interest in being able to look to the borrower to pay that difference. A deficiency judgment must be awarded by the court.
Whether or not a lender is allowed to pursue a deficiency judgment after executing a deed in lieu of trust varies by state. In an attempt to ensure fairness in the housing market, many states are clamping down on lender’s ability to obtain such judgments when an agreement was negotiated without involvement of the court. For example, California law prohibits a lender from seeking a deficiency judgment on any property transferred by deed in lieu of foreclosure, or other agreement reached outside the court.
Related Legal Terms and Issues
- Borrower – A person or entity that obtains funds from a business or person on the condition of promising to repay the loan, often with interest.
- Forbearance – The act of refraining from exercising a legal right.
- Lender – An individual, entity, or financial institution that makes funds available to another with the expectation that the money will be repaid.
- Mortgage Holder – A mortgage holder is a person or company that has a right to enforce a mortgage loan agreement.