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Deed in Lieu if Foreclosure: What it Can and Can't Do for You

By Gina Pogol
Mortgage Credit Problems Columnist


Steve Asks: Dear Gina, I lost my job six months ago and have been trying to sell my house ever since, but no one will offer me anything close to what I owe on it. A friend of mine suggested that I try a deed in lieu of foreclosure. I have no idea what this is. What is it and can it help me?

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Gina Says:

Dear Steve,

It sounds like a deed in lieu is a good solution for you if you can negotiate one. A deed in lieu of foreclosure is simply a non-judicial way of turning the property back to the lender without going through the legal hoops of foreclosure.

When Does a Lender Accept a Deed In Lieu of Foreclosure?

Lenders are more likely to agree to a deed in lieu of foreclosure when it is apparent that the borrower can't possibly pay the mortgage (for example does not have a job), and the property is worth less than the balance of loans against it. If your property were worth more, your lender could foreclose and sell it, thereby recovering the balance on the loan plus the costs of foreclosure. You would have little power to stop foreclosure in that case.

However, lenders know when they can't get blood from a turnip--those who simply have no assets to seize can't be forced to pay up, and lenders know they have to cut their losses--then, it makes sense to accept a deed in lieu of foreclosure. This process takes place outside the court system and is therefore much faster and less expensive than foreclosing on the property. FHA loans have their own rules, but normally, if you meet HUD guidelines, your FHA lender will accept your offer of a deed in lieu of foreclosure.

Deed in Lieu: What's in it for You?

The biggest advantage to you is that on your credit report a deed in lieu of foreclosure isn't quite as bad as a foreclosure. Most creditors, especially mortgage lenders, feel that foreclosure is the worst thing you can have on a credit report--you become pretty much untouchable for several years. A foreclosure can make your life even more difficult than it is already. First, the lender is likely to try to pass the high legal costs associated with foreclosing on to you. Second, those who don't live in non-recourse states (most people) could be forced to surrender assets to the lender if they owe more than the property fetches in a foreclosure sale. Third, other creditors may jack up your interest rates because you are perceived as a riskier borrower. Fourth, really bad credit can keep you from getting a job or insurance because statistics show that people with bad credit file more insurance claims and are less reliable employees.

How to Negotiate a Deed in Lieu of Foreclosure

Deeds in lieu of foreclosure are voluntary and take place outside the court system. That means you should expect some negotiation. Ideally, you would have a real estate attorney represent you and look after your interests. If you just take whatever is offered, you could end up with your lender chasing after you for fees and a deficiency judgment--in addition to a foreclosure on your credit report. What you want in a perfect world is a complete walk-away and a "paid-satisfactory" or at least "paid-settlement" on your credit report. The lender's reps may state that they can't do this but actually they can.

What if Your Lender Says No?

Talk to your representative about a short sale. This involves you dropping your asking price and selling the property for less than the balance of the mortgage--with the lender accepting the proceeds as payment in full. Again, you need to negotiate this--sometimes the lender agrees and then tries to get you to sign a note for the deficiency. Again, use an attorney if you need to--the idea is to keep a foreclosure off your credit report and make a clean break.

Good luck and thanks for writing,

Gina

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