What Is a Deed in Lieu of Foreclosure?
A deed in lieu of foreclosure, also known as a friendly foreclosure, is a contract between a lender and a borrower in which the borrower transfers the property to the lender. In turn, the lender waives the borrower’s mortgage debt and does not pursue foreclosure.
This deed helps borrowers who can no longer make mortgage payments, allowing them to avoid foreclosure. The lender gets the property back, and they waive all the borrower’s mortgage debts. The agreement should be in writing and signed by all parties before the conveyance of property and cancellation of debt can begin.
How Does a Deed in Lieu of Foreclosure Work?
The borrower must show financial hardship to use a deed in lieu of foreclosure. They can collaborate with their local bank or financial planner to compare their income against their expenses.
Once they have evidence of their inability to pay the mortgage, they present it to their lender and ask about their right to a deed in lieu of foreclosure. Some lenders don’t make this option available to their borrowers.
If they get the go-ahead, they legally sign the title to their property over to the lender. Once they’ve signed the deed, the lender will issue a mortgage release. That mortgage release then represents the satisfaction of mortgage debts.
Deed-in-Lieu Agreement vs. Foreclosure
A deed-in-lieu agreement and a foreclosure are two different processes. The first option allows the borrower to return the property to the lender on their own terms and avoid foreclosure. The latter happens when a lender takes possession of a mortgaged property involuntarily. Explore the differences between these two processes below to know when to use each.
| Difference | Deed in Lieu of Foreclosure | Foreclosure |
|---|---|---|
| Voluntary? | Yes; the borrower enters it voluntarily | No; it's a forced process |
| When to Use | When both parties agree to it and the borrower has no other liens | When the borrower and lender cannot reach an agreement |
| Effect on Borrower's Credit Rating | Minimal effect | Damaging effect; can harm their credit rating for years |
| Process Length | Relatively quick (30-90 days) | Longer (a few months to over one year) |
| Debt Forgiveness | The lender generally forgives all of the borrower's debt | The lender can pursue a deficiency judgment for the remaining loan balance after the sale |
| Public Record | Avoids becoming public record | Becomes part of the public record |
Pros and Cons of a Deed in Lieu of Foreclosure
Lenders and borrowers alike have complicated relationships with deeds in lieu of foreclosure. There are pros and cons to the use of this document for both parties:
Pros and Cons for the Lender
Pros for the Lender
- Regain the property in a shorter time period
- Avoid the repossession costs of a traditional foreclosure
- Can sell the property to another buyer
Cons for the Lender
- May acquire the property in poor condition
- May become responsible for secondary liens like junior mortgages
- Will become responsible for property taxes and Homeowners Association (HOA) dues
- May face delays or losses if the property is difficult to sell
Pros and Cons for the Borrower
Pros for the Borrower
- Avoid the time and stress of a public foreclosure
- Overcome substantial mortgage debt without going through court
- May allow for a more advantageous departure, such as negotiated move-out terms
Cons for the Borrower
- May trigger a large tax bill because the IRS views the cancellation of mortgage debt as cancellation of debt (COD) income
- Can damage credit rating (but not as severely as a foreclosure)
- Will lose the property they’ve worked to renovate and update
- May not be approved because it requires acceptance by the lender
How to Write a Deed in Lieu of Foreclosure
When drafting a deed in lieu of a foreclosure agreement, the parties need to include the following elements:
- The borrower’s and lender’s names and whether they’re individuals or entities
- The property’s location, including a street address
- The property’s legal description, either written in the document or attached as an exhibit
- The document used to arrange the mortgage, whether it was a promissory note, a loan agreement, or a mortgage note
- The date the mortgage was created
- The principal amount of the mortgage
- The registration information for the mortgage, including the date and location
- Whether the mortgage was registered as a deed of trust or a mortgage deed
- Statement of voluntary conveyance of the property by the borrower
- Statement that the lender will forgive all debts and forgo foreclosure
- Closing details, either within a specific period of the deed being signed or on a certain date
Depending on the lender’s requirements, the borrower may need to include documents to prove financial hardship. These may include budget and expenses, bank expenses, tax returns, and proof of income.
Lenders may also request borrowers submit hardship affidavits alongside primary evidence of a financial struggle. A hardship affidavit can detail a recent loss of income, an increase in housing expenses, or a reduction in assets.
Does a Deed in Lieu of Foreclosure Need to Be Notarized?
In most cases, a deed in lieu of foreclosure must be notarized. Notary acknowledgment allows the document to be recorded in public records and solidifies the transfer of ownership.
Sample Deed in Lieu of Foreclosure
View our deed in lieu of foreclosure template to get an idea of how to structure your document. Then, fill out your own using Legal Templates’s guided form. It will be available to download in PDF or Word format.
Alternatives to a Deed in Lieu of Foreclosure
Before deciding on a deed in lieu of foreclosure, you may consider other options:
- Loan modification: The parties may update the loan with new terms, such as a lower interest rate, that are more manageable for the borrower.
- Repayment plan: The lender may allow the borrower to catch up on missed payments with a repayment plan.
- Short sale: With a short sale, the borrower sells their home for far less than its market value. In turn, a lender can relieve them of their mortgage debt.
- Refinance: The borrower can secure a new loan with better terms.
- Partial claim: The borrower’s insurance company can lend them money to bring them up to speed on payments. This process creates a second loan that the borrower pays later.
- Bankruptcy: Bankruptcy restructures debt to give the borrower a fresh financial start.
