Recently lenders have been taking homeowners' deeds in lieu of the foreclosure process to get title to their homes. The lender simply accepts a deed in exchange for forgiving the homeowner of his mortgage or deed of trust loan, however, this does not mean the homeowner is no longer responsible for a loan deficit.



Let's look more closely and see the ramifications of this legal transaction. It usually starts after the homeowner has fallen behind on his loan payments and is considering foreclosure, or he has already been served with a "default notice". Time is working against the homeowner because the lender will, or already has, started foreclosure proceedings.

The homeowner is being bombarded by outside information sources because his foreclosure has become a part of the public record or he is getting information from well-meaning but uninformed people.

As soon as the homeowner notifies the lender of his impending problem or his loan is delinquent, the lender orders an appraisal or BPO (Broker's Price Opinion) to determine its market value.

The lender now knows if he can make money on the property if he takes it back at a foreclosure auction or by having the homeowner give the deed back to the lender. The lender's decision will be strictly financially motivated from this point forward.

The risk of taking the property by foreclosure includes the higher legal costs, an extended loss of interest on the loan, real estate market risk, realtors' commissions, carrying and closing costs, and increased reserve requirements for the Federal Reserve.

However, the most important issue for the lender is any other open liens on the property that would normally be extinguished at the auction, but will remain in place if the deed is transferred.

The lender now factors in the minimal cost and shorter time required to get the home by taking a deed from the homeowner, in lieu of continuing the foreclosure, and whether there are additional mortgages, deeds of trust or liens on the property, and the property's market value. Sometimes these liens can be larger than the first mortgage and the lender will not accept the property with these liens still attached to it.

If the appraisal or Broker's Price Opinion (BPO) comes back with a value of 80% or less of the loan balance due, the lender would be irresponsible to take the deed and not continue the foreclosure.

If the lender agrees to accept a deed in lieu of foreclosure, it is not completely over for the homeowner. The lender will submit an Acceptance Agreement that the homeowner must sign as well as a new deed. The terms of this agreement may stipulate that if the lender sells or transfers the property for less than what is owed on the loan (including all penalties, interest, and attorneys' fees), the guarantor of the loan will owe the lender this difference.

This deficiency amount can then be granted by the courts as a deficiency judgment against the loan guarantor. Usually this deficiency amount will be passed to the homeowner in the form of an IRS Form 1099 and become "Phantom Income" on his next tax return. Federal legislation enacted in December 2007 allows the homeowner to avoid taxes on this amount under certain circumstances.

So is the "Deed in Lieu of" an ideal solution for a homeowner in foreclosure? Not unless the terms of the Acceptance Agreement release the guarantor from future liability (deficiency judgment). The issue is that if this isn't a better solution for the lender, the lender has no motivation to take back the deed. So the option of a "deed in lieu of foreclosure" is only workable if the lender can see that they will do better than foreclosing.

If there are other liens on the property these liens will have to be "extinguished" or canceled before a deed is accepted by the lender.