What Is a Deed in Lieu of Foreclosure, and Should You Sign One?

A deed in lieu of foreclosure is a voluntary transfer of your house to the lender in exchange for the lender dropping the foreclosure. It can be the cleanest way out of a house you can’t keep, but only if the lender agrees in writing to waive the deficiency, the balance still owed after the house is credited against the loan.

Without that waiver, you can hand over the keys and still owe money.

How does a deed in lieu work?

You sign a deed transferring the house to the lender, and the lender takes it instead of finishing the foreclosure. Both sides have to agree, and neither side is bound until the final agreement is signed.

For the lender, it saves the time and cost of a foreclosure. For you, it ends the matter on terms you negotiate, not on an auction date.

When will a lender accept a deed in lieu?

Not always. Lenders tend to accept one when a few things are true:

• Clean title. The lender wants the house free of other liens. A second mortgage, a home equity line, a tax lien or a judgment against you usually makes a deed in lieu much harder.
• A sale attempt first. Many servicers want you to try a short sale, meaning a sale to an outside buyer for less than you owe, before they will take the deed.
• A documented hardship. You will usually go through the servicer’s loss mitigation review, with the same financial package you would send for a modification.

A deed in lieu is often the last option in that review, after a modification has been denied. Here is how foreclosure loss mitigation works.

What should I negotiate before I sign?

Everything that matters goes in writing before you sign the deed.

• A full deficiency waiver. The agreement should say the transfer satisfies the debt in full and the lender will not pursue you for any remaining balance. A promise to stop the foreclosure is not the same thing.
• A move-out date. Agree on when you have to be out and what condition the house has to be in.
• Relocation money. Some lenders and loan programs offer cash toward moving costs as part of a deed in lieu. Ask for it.
• Credit reporting. Ask how the account will be reported. It will still be negative, but a deed in lieu is often reported differently from a completed foreclosure.

If there is a second mortgage, that lender is a separate negotiation, and the first lender’s waiver does not cover it.

Will I owe taxes on the forgiven debt?

Possibly. The IRS generally treats canceled debt as income, so a deficiency the lender forgives can show up on a 1099-C, the form a lender sends reporting canceled debt.

There are exceptions. If you were insolvent when the debt was canceled, meaning your debts were more than the value of everything you owned, some or all of it may not be taxable, and debt discharged in bankruptcy is not taxable income.

Rules for mortgage debt on a main home have changed over the years, so talk to a tax preparer before you assume either way.

Is a deed in lieu better than a short sale or foreclosure?

Compared to a short sale. A short sale may bring a better price, but it takes a buyer, an agent and the lender’s approval of the price. A deed in lieu is simpler once the lender agrees, and the deficiency waiver question is the same in both.

Compared to letting the foreclosure happen. A foreclosure takes the decision out of your hands, and the price at auction is often low, which leaves a bigger deficiency for the lender to chase. A deed in lieu with a written waiver usually beats it, and one without a waiver may not.

Does it matter whether I am in Virginia, Maryland or DC?

Yes. Your deficiency exposure depends on where the house is.

Virginia. Virginia lenders can sue for a deficiency after a foreclosure, and most Virginia foreclosures are trustee’s sales that happen outside of court and move quickly. In Fairfax, Arlington, Alexandria or Prince William, the waiver in a deed in lieu matters a great deal.

Maryland and DC. Lenders can pursue a deficiency in Maryland and DC too, but the foreclosure process there has more steps and usually takes longer. In Prince George’s County, Montgomery County or DC Superior Court, that extra time can give you more room to negotiate, but you should still insist on the waiver.

Here is more on foreclosure defenses in Virginia, Maryland and DC.

What if I have other debt besides the house?

Then a deed in lieu may not be the whole answer. If you also have credit cards, medical bills, a car loan or a second mortgage, bankruptcy can deal with the house and the rest at once.

Chapter 7 wipes out your personal liability on the mortgage, so no deficiency can follow you, and it discharges most other unsecured debt too. If you would rather keep the house, you can file Chapter 13 to stop the foreclosure and catch up over time.

Sometimes the right answer is both. A bankruptcy handles the debt, and a surrender or deed in lieu handles the house.

What should I do right now?

If you are thinking about a deed in lieu, call me at (202) 448-5136 before you sign anything. Bring the lender’s letters, your latest mortgage statement and any agreement the servicer has sent you.

The consultation is free. I will read the terms, tell you whether the deficiency is really waived, and tell you whether bankruptcy or another option would leave you better off.

I handle cases in DC, in Maryland at the Greenbelt courthouse, and in the Eastern District of Virginia. Don’t sign until the waiver is in writing.