A deed in lieu of foreclosure is an agreement where a borrower voluntarily transfers ownership of their property to the lender to satisfy a defaulted mortgage or loan and avoid formal foreclosure proceedings.
It benefits the lender, if the borrower is cooperative, in that it does not have to advertise and conduct a foreclosure. It may benefit the borrower by giving some room to make a dignified exit from her property. Sometimes, the lender will even offer money for moving.
It will still be a hit to a borrower’s credit and will likely prevent her from getting certain loan types, like a FHA loan, for several years.
If you are able to sell the house, you will almost certainly do better. A good realtor will be adept at this, knowing who will buy a house in this situation, and realizing that speed is essential.
In my experience, a candidate for a deed in lieu has a relationship with the lender, often a smaller lender, and doesn’t have the wherewithal to get the house ready for a proper listing and sale.
How it works:
The borrower is in default (or about to be).
Instead of going through foreclosure, the borrower (the homeowner) signs a deed transferring the property to the lender.
In return, the lender cancels the debt (in whole or sometimes in part). Beware, often the lender does not cancel the debt when the deed in lieu is transferred. The deed in lieu will have a provision about this, that the lien is not cancelled. Instead, the lender waits until it transfers the property again, to a third party, before it cancels the lien of the borrower. The lender does want to give up any of its rights to the debt in case something unexpected happens to the borrower.
Key Features:
Avoids foreclosure: Less damaging to the borrower’s credit than a formal foreclosure.
Saves time and costs: Lenders can regain title without going through court or auction.
Typically requires lender approval: The lender won’t accept a deed in lieu unless they’re confident there are no junior liens or title defects.
No deficiency judgment: Many agreements specify that the lender won’t pursue the borrower for any unpaid loan balance.
Risks:
If there are other liens, the lender will prefer foreclosure to wipe subordinate liens. Plus, the “seller” is still on the hook for those liens.
It’s generally considered loss mitigation—not debt forgiveness for tax purposes, so the borrower will likely get a 1099 and might have to pay substantial taxes.
The borrower will still likely take a big credit hit, but sometimes not as big as a foreclosure.
A bankruptcy court could strike the deed in lieu, if it appears the lender is trying to get around priority rules.