What is Deed in Lieu?
There are many options our housing counselors can explore with homeowners who are struggling with mortgage debt. One option is the deed in lieu of foreclosure.
A deed in lieu allows the borrower who is in danger of foreclosure the chance to give the property directly to the lender to satisfy the outstanding loan. This can even satisfy a loan that is underwater, or in default. This can be an alternative to a short sale, where the property is sold to a third party for less than the total amount owed. If no third party buyer can be found, a deed in lieu may be the next best option.
Advantages of deed in lieu
- The borrower no longer owes anything on the mortgage loan if the debt is nonrecourse, meaning the borrower is not personally liable for any deficiency (beyond the value of the property). Credit.org encourages our clients to seek appropriate guidance from a tax professional such as an accountant or attorney to discuss their potential tax liability.
- Foreclosure is avoided.
- Credit may not be damaged as much as with a foreclosure.
- The lender takes possession more quickly and with less expense than foreclosure.
- No need for a formal eviction by the sheriff’s department.
- Increases the chance the borrower will leave the property in good condition.
Disadvantages of deed in lieu:
- Any debt forgiven in this arrangement may be treated as “ordinary income” under certain circumstances, and may be subject to taxation. However, a claim of insolvency may provide relief from cancellation of debt income. The borrower may have significantly different tax liability depending on the disposition of the property. Consequently, the borrower must discuss with their own tax advisor before making a decision.
- Credit will be affected negatively (not as much as foreclosure, but there will be a negative impact). This stays on one’s credit report for seven years.
- Getting free of the debt doesn’t always solve the underlying financial problems.
- Borrower is left without a home to live in.
As you can see, there are advantages to both the borrower and the lender in a deed in lieu situation. Still, this is something that must be entered into with great care and only after other options have been exhausted.
A deed in lieu is a voluntary arrangement between the lender and borrower. If the outstanding debt far exceeds the fair market value of the property, the lender may not agree to this option.