Deed in lieu of foreclosure: Will this work for you?

When people are facing the loss of their house in foreclosure, they often hear about “deed in lieu of foreclosure” being a good option for them.

For instance, one person recently wrote that they are victims of a “two year ARM nightmare”, one that raised their mortgage by about $500 per month. Now they can’t pay the new payment, their credit has gotten really bad and they cannot refinance either. They ask, “can we do a deed in lieu?”

Deed in lieu of foreclosure involves your moving out of your house and essentally giving the keys back to your lender.

In practical terms, you sign over a warranty deed, quitclaim deed or grant deed to your lender. Then you no longer own the house. The lender does. But the lender also has all the liens that are on the house, of course.

In theory, you accomplish several goals. One, you avoid a protracted foreclosure process. And two, your lender should be happier than they would otherwise be, because they have your full cooperation.

So why is a deed in lieu of foreclosure something that is rarely done?

Lenders don’t like deed in lieu of foreclosure

The lender ends up with the house with all the liens on it. A foreclosure, on the other hand, ends in a “trustee’s deed” or something similar (depends upon which state your in), and this extinguishes any other liens on the house except for unpaid property taxes.

If you have a second mortgage, a deed in lieu of foreclosure gives the lender back the house including the second mortgage. A foreclosure process would wipe out the second mortgage.

Lenders don’t like the deed in lieu of foreclosure. They would rather get the house after it’s been sanitized of any other junior liens.

Also, why do a deed in lieu anyway? It doesn’t help your credit. A deed in lieu of foreclosure shows up the same as a foreclosure. It pretty much is the same thing. So you cooperated. The credit report isn’t going to look better.

Lenders don’t like them. They are very hard to do. And they don’t look better on your credit report. So what should you do?

One thing you may consider doing is putting your payments into a bank account that you can use to build a nestegg for yourself, in case you have to move and rent a place. You have to start thinking clearly about this. If you are going to lose your house, you will need a place to live. Instead of counting on something that is rarely done and hard to do, why not take steps to prevent yourself from being homeless?

Once you have a foreclosure, there is plenty of life left. A foreclosure is better than a bankruptcy in terms of your credit. It may drop your FICO credit score 50 points or maybe 100 points, but that is far better than bankruptcy. Sure, you won’t be able to get a new home loan right away. But the same bad environment that resulted in your losing your home also puts you in a unique position. You can actually buy something else straightaway by doing a “subject to” purchase, if you know how, and you can be a homeowner with no bank qualifying.

It pays to be very optimistic because things can really work out well. But please know your options and think realistically about them.

A deed in lieu of foreclosure is rarely a realistic option.