What Happens in Deed in Lieu?

A deed in lieu is one way to avoid foreclosure according to Martina Knight from bestmanchestersolicitors.co.uk.

Homeowners whose home value has fallen below the amount owing on their mortgage have options short of bankruptcy to avoid foreclosure when they can no longer afford the mortgage. One is to sell the house for less than the mortgage balance, which is called a short sale, and another is to give the property back to the lender. The latter option is called a deed in lieu of foreclosure.

Deed in Lieu Basics
In a deed in lieu, the homeowner requests that the lender agree to the step. If it does, both sign a deed giving full ownership of the property to the lender. In exchange, the lender cancels the loan and may agree to forgive the deficiency between the amount it obtains by selling the property and the amount owing on the mortgage. Attorney Stephen Elias advises homeowners to obtain the latter agreement in writing (ref. 1). Once the homeowner has signed over legal rights to the property to the lender, he must vacate the property. The process is often characterized as “walking away.”

Tax Consequences
The homeowner may incur an extra tax burden at the end of the year in which a deed in lieu was completed. This can happen when debt is forgiven by the lender. The Internal Revenue Service requires the lender to document the forgiven amount on form 1099-C and regards it as income for the homeowner. The Mortgage Debt Relief Act of 2007 provides an exemption for canceled debt, however, if the debt was secured by the taxpayer’s primary residence and was used for purchase of or improvements to that residence.

Requesting a Deed in Lieu
Mortgage lenders do not automatically consider a deed in lieu of foreclosure and usually only do so upon request of the debtor. The request must be in writing and must include documentation of a financial hardship. It must also include a detailed financial statement from the debtor. Some lenders will only consider a request if the house has been on the market for a fixed period — usually three months.

During periods of heavy foreclosure activity, it can be difficult to get a lender to agree to a deed in lieu because the lender incurs the responsibility for disposing of the property at a time when prices are low. Borrowers who do get their lenders to agree to one sustain damage to their credit. CNN reports a deed in lieu, like a foreclosure, can lower a credit score from 85 to 160 points, and the impact on the borrower depends on how high his credit was before the transaction. Those with higher scores have more to lose.