If you fail to make payments on your home mortgage and go into default, then your lender is likely to initiate foreclosure proceedings to seize the property. If the borrower cannot pull together the funds to cure the default, then it is just a matter of time before the property is in the possession of the bank and the borrower is stuck with long-lasting financial consequences and credit damage. However, there may be some options that homeowners can pursue to either prevent the foreclosure or minimize the resulting harm:
- Ask Lender for a Repayment Plan or Forbearance – The bank may allow you a fixed amount of time to pay the amount you are behind (plus late fees) by temporarily adding more to your monthly payment. In the alternative, your lender may agree to suspend monthly payments temporarily to get over a temporary emergency, but will require a lump sum or periodic catch-up payments in the near future. Both of these options are at the discretion of the lender.
- Loan Modification – Your lender may agree to modify the terms of your loan by modifying the interest rate, extending the payment period, or adding past-due payments to the loan balance. The bank will only be agreeable to this if they have confidence that the borrower has the financial ability in the near future to stay on top of the modified payments.
- Short Sale or Preforeclosure Sale – The borrower can always sell their home, pay off the loan with the proceeds and downsize. However, if the home is underwater and the sale proceeds won’t cover the entire balance, the borrower may be able to negotiate with the bank to accept a short sale and take all of the proceeds from a real estate transaction in exchange for forgiving the balance of the loan. The lender may accept this arrangement if it believes this may realize more money than paying for foreclosure proceedings. The borrower, however, will still suffer some damage to his or her credit score.
If none of the above options are viable, then the borrower may consider asking the lender to accept a deed in lieu of foreclosure.
A deed in lieu of foreclosure is a settlement agreement where the borrower elects to give title to the secured property to the lender immediately without having to go through the entire foreclosure process. This can also be used with respect to a land contract to avoid foreclosure and forfeiture proceedings where the buyer conveys his interest back to the seller. There is a potential benefit in both directions. The lender receives title to the property immediately without having to spend additional money on foreclosure proceedings. The borrower avoids receiving a foreclosure on his or her credit history and avoids a deficiency judgment. Essentially, the borrower gives away the property and his statutory right of redemption in exchange for the lender forgiving the loan and giving up the right to pursue any unpaid balance on the debt.
The lender must agree to accept a deed in lieu of foreclosure instead of pursuing other collection options. There may be valid reasons why the bank would refuse this arrangement. First, the property value may be far below the balance of the debt owed (due to market prices or poor condition), so the bank may not want to give up their right to pursue a deficiency judgment. Second, the bank may not be interested in acquiring ownership to property that has to be maintained and managed until it is sold. Third, the bank may not want to take possession if there are issues in the title history of the property that can create future problems. A borrower may have to complete a title search or acquire title insurance before approaching the lender. There is no guarantee that the bank would accept this offer.
If the lender does accept, then there will be a number of documents that will have to be completed and executed at a scheduled closing. At least two documents will be recorded at the register of deeds memorializing the transaction. The first document is the quitclaim deed itself which explicitly conveys all of the borrower’s interest in the property to the lender and extinguishes the borrower’s six-month right of redemption that he or she would have following a foreclosure sale to pay the balance of the loan (plus costs) and recover the property. The second document is an estoppel affidavit that spells out the consideration that the borrower is offering in exchange for the lender waiving the right to pursue any deficiency judgment, namely:
- There are no other liens or mortgages on the premises.
- There are no unrecorded documents encumbering the premises.
- There are no unpaid current real estate taxes, personal property taxes, or assessments or delinquent real estate taxes, personal property taxes, or assessments due.
- Borrower has not assigned or conveyed any interest in the premises or mortgage.
- Borrower will not, in the future, encumber or assign any interest in the premises.
- Borrower waives all redemption rights in the mortgage or the premises.
- Borrower has not entered into a lease or any other agreement that would give any other party a possessory interest in the premises.
- Borrower is solvent, not under a legal disability, and not involved in bankruptcy proceedings.
- Borrower will remove all personal property from the premises without damage or waste to the physical structures.
The end result of a deed in lieu of foreclosure is that you will lose your home. However, a deed in lieu of foreclosure has some advantages over a completed foreclosure process that may help the former borrower get back on his or her feet sooner:
- FUTURE FANNIE MAE LOAN: Generally, a homeowner who loses a home to foreclosure is ineligible for a Fannie-Mae backed mortgage for a period up to 7 years. However, a homeowner who transfers the real estate to the lender via a deed in lieu of foreclosure will be eligible for a Fannie Mae backed mortgage after only 4 years (or 2 years if there were extenuating circumstances). B3-5.3-07. Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations such as divorce, death of family member, job loss, high medical bills or major casualty to property such as fire. B3-5.3-08.
- CREDIT SCORE HIT: A foreclosure can result in a drop up to 300 points on the borrower’s credit score for 7 years. However, the drop is much lower from a deed in lieu of foreclosure, generally between 50 and 150 points. A deed in lieu of foreclosure is generally reported as “paid as agreed”, “paid as negotiated” or “settled”. Any late payments leading up to the deed in lieu of foreclosure will also reduce credit score somewhat, but not as severely as a foreclosure or even a bankruptcy.
- CREDIT HISTORY: A foreclosure will appear and remain on a person’s credit history for at least 10 years. However, a deed in lieu of foreclosure generally remains on a person’s credit history for 3 to 5 years.
- DEFICIENCY JUDGMENT: A foreclosure sale may not satisfy the full unpaid amount of the mortgage, so the lender could add insult to injury by pursuing a deficiency judgment against the borrower for the unrecovered balance. However, the lender explicitly waives any right to a deficiency judgment through a deed in lieu of foreclosure so the borrower can walk away without further liability.
However, there are still some drawbacks to a deed in lieu of foreclosure that have to be considered:
- NO MONEY RECEIVED FROM DEED IN LIEU OF FORECLOSURE: On its face, the borrower explicitly surrenders all interest in the property to the lender without receiving a single dollar in return. Any profits or proceeds that can be realized from a future sale will be retained by the lender.
- LENDER MAY NOT APPROVE AND WASTE TIME: Despite providing everything requested by the lender for a deed in lieu of foreclosure, the lender may still not accept and move forward with traditional foreclosure proceedings. This wasted time could have been better spent on the borrower pursuing other alternatives.
- TAXES MAY BE OWED ON FORGIVEN DEBT: After the deed in lieu of foreclosure is completed, the lender will forgive the mortgage debt owed. However, the Internal Revenue Code considers forgiven debt to be taxable income. The lender will issue Form 1099-C to both the borrower and the IRS indicating the amount of the loan that was forgiven, so you can be sure that the federal government will be looking for the borrower to declare that amount on his or her income tax return and pay any taxes owed. It is possible that this amount can fall under the sale of primary residence exclusion for gain, but you should consult with a tax professional to be sure if this will apply to your situation.
- FUTURE FHA LOAN: Unfortunately, a deed in lieu of foreclosure has the same effect as a foreclosure for the purposes of obtaining a future FHA loan. Generally, “[a] borrower is generally not eligible for a new FHA-insured mortgage if the borrower had a foreclosure or a deed in lieu of foreclosure in the three-year period prior to the date of case number assignment.” HUD 4000.1. A three-year mandatory waiting period starts, “on the date of the deed in lieu of foreclosure or the date that the Borrower transferred ownership of the Property to the foreclosing entity/designee.” However, there are some exceptions to the three-year rule. “The [lender] may grant an exception to the three-year requirement if the foreclosure was the result of documented extenuating circumstances that were beyond the control of the borrower, such as a serious illness or death of a wage earner, and the borrower has re-established good credit since the foreclosure.”
A deed in lieu of foreclosure may be a good option if you fall behind on your mortgage and can’t get back ahead, but whether or not it fits your situation is best determined in consultation with skilled legal counsel. If you or a loved one have further questions about deeds in lieu of foreclosure or need legal representation, then do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC for assistance today.