How Deed in Lieu of Foreclosure Works
Deed in lieu of foreclosure (DIL) is an option for avoiding foreclosure and breaking free of high housing payments. Instead of waiting for a lender to foreclose on a home, you can voluntarily transfer ownership to the lender. Essentially, you sign the deed over, and your lender releases you from the obligation to make payments.
When you’re unable to afford mortgage payments, unable to get a loan modification, and unable to sell your home, a DIL transaction is a way to get rid of your home.
Credit reports: DIL looks slightly different on your credit reports than a standard foreclosure, but the result may be the same. Your bank takes the property and sells it to pay off your loan, and in many cases, your credit scores will drop just as if you went through foreclosure. But you might be able to borrow again sooner, and a human looking through your credit reports (as opposed to a computerized scoring model) might view DIL more favorably than foreclosure. If you can’t do anything else (like a short sale, loan modification, or open-market sale), you’ll come out looking better with DIL.
Deficiency: When your lender sells your house, the house might sell for less than you owe. What happens to the money you still owe? Your lender may try to collect that deficiency, which means your loan is not yet completely behind you. But, in some cases, you can have the deficiency wiped out in a DIL transaction, or you can negotiate for a smaller deficiency. Review your agreements carefully with a local attorney, and ask a tax preparer about any liability you might have for forgiven debt (or other aspects of the deal).
Speed: DIL can be faster than other options, so you can stop making your monthly payments (and move on to more affordable housing). If you’ve already stopped making payments and are waiting for foreclosure, the financial difference might not matter. But DIL gets things in motion so that you can hopefully buy again or rebuild your credit more quickly. It’s wise to expect around 90-days for processing time.
Financial assistance: Some DIL programs help you get back on your feet. You may be able to live in your home for three months rent-free, or you might receive relocation assistance (typically up to $3,000) to ease your transition.
Privacy: You might not care who knows about your dealings, but DIL is less public than foreclosure. DIL is an agreement between you and your bank—not a legal proceeding authorized by your state that ends up in public records.
Appealing to lenders: Banks also benefit when you use DIL. Foreclosure is expensive, time-consuming, and risky for lenders. They’d rather put an end to things quickly. That said, banks don’t always agree to let you release your home this way. If you have other liens on your home (including a second mortgage), DIL might not be an option.
Drawbacks and Alternatives
Credit scores: Deed in lieu of foreclosure damages your credit. But you might not have other options, and if you’re going to miss monthly payments and eventually default anyway, that might not matter.
New housing: With DIL, you must move out of your home. You stop making payments and the bank will own the property, so you’ll need to find alternative accommodations.
Limited relief: DIL is just an agreement between you and your primary mortgage lender. If you owe money to others (for a second mortgage, HOA expenses, taxes, and so on), you’ll still owe that money.
Alternatives: In some cases, a short sale is a better option than DIL. With a short sale, you still might be able to get any deficiency waived (again, read through the agreements with a local attorney), and you do less damage to your credit. Also, loan modifications might offer a less-drastic solution, and see if refinancing is still an option.
To get a mortgage release, you need to work with your lender. Every lender has different requirements, so call and ask about the process. Let them know you’re unable to make your payments, and be sure to discuss all of the alternatives (such as loan modification, short sale, government programs like HARP 2.0, and so on).
- Contact your lender, explain your situation, and ask to begin the DIL process. You’ll need to fill out an application and show proof that you’re unable to make your payments due to hardship.
- Provide documents that show your income, monthly expenses, and bank account balances. Your lender needs to understand that you’re facing an impossible hardship, and that there’s no way you’re going to be able to pay.
- Respond to requests for additional details, and allow time for your lender to process your request. Expect to wait 30 days or more before you hear an answer, but it never hurts to call and ask for a status update. Nothing will happen quickly, but it should be faster than foreclosure (or even an open market sale).
- If approved, get advice. Before you sign any final documentation (and during the entire process), consult with a local real estate attorney. This will cost several hundred dollars, but any “misunderstanding” could easily cost ten times as much—or much more. Pay particular attention to how any deficiency will be treated.
- When it’s time to move out, leave the property clean and in good condition. Remove all personal belongings and debris so that the property is ready to go on the market.