How Deed in Lieu of Foreclosure Works

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Deed in lieu of foreclosure (DIL) is one of several options for getting out of a home loan. Instead of going through foreclosure, you can voluntarily transfer ownership to your lender (who would’ve taken it anyway) – essentially you sign the deed over and hand over the keys.

Why DIL?

If you’re unable to make your mortgage payments, unable to get a loan modification and unable to sell your home, a DIL transaction might be your best way out.

Credit reports: DIL looks slightly different on your credit than plain-old foreclosure, but the end result is the same – your bank takes the property and sells it to pay off your loan. 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 feel better about DIL than foreclosure. If you can do anything else (like a short sale, loan modification, or open-market sale), you’ll come out looking better.

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 might try to collect that deficiency, which means your struggles are not over yet. However, in some cases, you can have the deficiency wiped out in a DIL transaction. Be sure to review your agreements carefully with a lawyer, and ask a tax preparer about any liability you might have.

Speed: DIL can be faster than other options, meaning you can stop making your monthly payments (and move on to more affordable housing).

Privacy: although you might not care (and nor does anybody else), DIL is less public than foreclosure. It’s an agreement between you and your bank – not a legal proceeding authorized by your state.

The bank also benefits when you use a deed in lieu of foreclosure. Foreclosure is expensive, time-consuming, and risky for banks. They’d rather put an end to things quickly, which is why they agree to these transactions.

That said, banks don’t always agree to let you release your home this way. If you have other liens on your home (perhaps you got a second mortgage at some point), your bank might be unwilling to go ahead with DIL.

Drawbacks

A major drawback of a deed in lieu of foreclosure is that you’ll hurt your credit. However, you might not have other options, and if you’re going to miss monthly payments and eventually default anyway, that might not matter.

Note that with DIL, you must move out of your home. You’ll stop making payments and the bank will own the property, so you’ll need to find alternative accommodations.

Given those drawbacks, a short sale might be 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’ll do less damage to your credit.

Also, DIL is just an agreement between you and your mortgage lender. If you owe money to others (for a second mortgage, HOA expenses, taxes, and so on), you’ll still owe that money.

DIL Process

To get a mortgage release, you’ll need to work with your lender. Every lender has different requirements, so you’ll need to 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).

With most lenders, you’ll need to fill out an application, and you’ll need to show proof that you’re unable to make your payments. Plan on providing documents that show your income, monthly expenses, and bank account balances. Your bank needs to understand that you’re facing an impossible hardship, and that there’s no way you’re going to be able to pay.

It takes time for your bank to process a DIL application. 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 still might be faster than foreclosure or an open market sale).

Before you sign any final documentation (and during the entire process), get guidance from a local real estate attorney. This will cost several hundred dollars, but any “misunderstanding” could easily cost ten times as much – or much more. You’ll want to be especially sure you understand how any deficiency will be treated.