What Is a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure involves a homeowner transferring ownership of their house to their mortgage lender instead (“in lieu”) of going through the foreclosure process. It’s just one way to avoid foreclosure, however, and isn’t right for everyone facing difficulties making their mortgage payments.

How a deed in lieu of foreclosure works

A deed in lieu of foreclosure — also called a “mortgage release” — allows you to avoid the foreclosure process by releasing you from your mortgage payment obligation. You voluntarily give up ownership of your home to your lender, and in doing so may be able to:

• Stay in the house longer
• Avoid paying the difference between your home’s value and your outstanding loan balance
• Get help covering your relocation costs

Lenders aren’t obligated to agree to a deed in lieu, but they often do to avoid the longer and more costly foreclosure process.

Does a deed-in-lieu affect your credit?

Yes, a deed in lieu will negatively impact your credit score and that impact will be roughly the same as the impact of a short sale or foreclosure. That’s one reason why a deed in lieu is usually a last resort option. If you’re eligible for a refinance, mortgage modification, forbearance, lump-sum reinstatement or short sale, you should pursue those options first.

Deed in lieu of foreclosure process: 4 steps

1. Reach out to your lender.

Let them know the details of your situation and that you’re considering a deed in lieu. You’ll then fill out an application and submit supporting documentation about your income and expenses.

Based on your application, the lender will assess:

• Your home’s current value
• Your outstanding mortgage balance
• Your financial hardship
• Your other liens on the property, if any

2. Create an exit plan.

If your lender agrees to the deed in lieu, you’ll work with them to determine the best way for you to transition out of homeownership.

For example, if you get a Fannie Mae mortgage release, your choices will include leaving the home immediately, living there for up to three months rent-free or leasing the home for 12 months. The lender may require that you attempt to sell the house before the deed in lieu can proceed.

3. Transfer ownership.

To complete the process you’ll sign documents that transfer the property to your lender:

• A deed, the legal document that allows you to transfer ownership (or “legal title”) of the property to someone else.
• An estoppel affidavit, which spells out in detail what you and your lender are agreeing to. If your lender agrees to forgive your deficiency — the difference between your home’s value and your outstanding loan amount — the estoppel affidavit will also reflect this.

Once you sign these, the home belongs to your lender and you won’t be able to reclaim ownership.

4. Assess your tax situation.

If your lender agreed to forgive a portion of your mortgage debt as part of the deed in lieu, you may have to pay income tax on that forgiven debt. You might avoid this tax if you qualify for exemption under the Consolidated Appropriations Act (CAA). If you think you qualify, consult a tax professional who can help you nail down all the details.

If you don’t qualify, be aware that the IRS will know about the income, since your lender is required to report it on Form 1099-C.

Pros and cons of a deed in lieu of foreclosure

What can prevent you from getting a deed in lieu?

Here are common issues that make a deed in lieu unacceptable to many lenders:

• Encumbrances, tax liens or judgments against the property. Banks often don’t want to agree to a deed in lieu when the property has any legal action other than the original mortgage attached to it. In those cases, the lender has an incentive to go through foreclosure, as it’ll get rid of at least some of these (for instance, a foreclosure would clear any liens other than the original loan).
• Payment requirements. If the loan is owned by a mortgage-backed security, it’s possible that it has a pooling and servicing agreement (PSA) attached to it. If it does, the borrower may be required to pay some amount toward the debt in order for the owners of the mortgage-backed security to agree to a deed in lieu.
• Low home value. If your home has significantly depreciated in value, it may not make financial sense for the lender to agree to a deed in lieu. Lenders may pursue foreclosure instead if you’re offering to hand over a house that has very little value, requires extensive repairs or isn’t sellable.

Foreclosure or deed in lieu: Which is right for me?

A deed in lieu might make sense for you if:

• You’re already behind on your mortgage payments or expect to fall behind in the near future.
• You’re facing a long-term financial hardship.
• You’re underwater on your mortgage (meaning that your loan balance is higher than the home’s value).
• You’ve recently filed for bankruptcy.
• You either can’t or don’t want to sell your home.
• You don’t have a lot of equity in the home.

Foreclosure may make more sense for you if:

• You have significant equity
• You have liens, encumbrances or judgments against the property
• Your lender isn’t offering concessions, like relocation assistance, more time in the home or release from your obligation to pay the deficiency

Another alternative to foreclosure: Short sale

As mentioned above, most people pursue a refinance, loan modification, mortgage forbearance or short sale before a deed in lieu. All of these options, excluding a short sale, will allow you to stay in your home.

Deed in lieu vs. short sale

A short sale means you’re selling your home for less than what you owe on your mortgage. This may be an option if you’re underwater on your home and are having trouble selling it for an amount that would pay off your mortgage.

However, with a deed in lieu, you transfer ownership directly to your lender and not a typical homebuyer.

Moving forward after a deed in lieu of foreclosure

You may feel hopeless about your ability to buy a home again after signing a deed in lieu or losing a home to foreclosure. But the good news is that, as long as you recover financially, you’ll be able to qualify for a mortgage after a foreclosure or deed in lieu.

Each loan type has its own mandatory waiting periods and qualification requirements for buyers who have a deed in lieu on their record, listed in the table below. Most waiting periods are the same for a deed in lieu and a foreclosure.