What is a “Deed in Lieu of Foreclosure”?

In the real estate world, when foreclosure is imminent, many real estate owners will consider the “deed in lieu of foreclosure”. Because of the complexity that often surrounds real estate transactions, let me explain exactly what a “deed in lieu of foreclosure” is.

Before the 1980s, a deed in lieu of foreclosure was often used to resolve a situation where the owner of real estate could not pay for the real estate. Because real estate loans were always made for only 4/5 of the value of the real estate, and prices were stable, a lender never lost money when accepting a deed back in place of a foreclosure.

But over the last 30 years, real estate transactions have involved far less money put down by fewer purchasers, and  lenders are often faced with taking back properties where they will have a loss. In these cases, when a lender has a property worth not much more than the loan amount, it’s easy for him to lose money.

Here’s an example. Suppose the borrower buys a property for $100,000 and puts $10,000 down. In this case, he has a “loan to value ratio” of 90%, and the amount of value in the property is 10%. This 10% is known as his “equity” in the property. In a case where he can no longer make payments, the property has not escalated in value, and there has been very little paid down on the loan, the lender who has to take the property back is in a difficult position.

While the foreclosure occurs, the lender will have carrying costs for at least six months (perhaps as long as a year), and will lose money. Further, if the property needs to be fixed up before it can be sold, the lender loses money again. In addition, the cost of a realtor and other miscellaneous closing costs can create another loss.

Obviously, lenders like to make real estate loans where 1) a substantial equity exists in the property, 2) the property does not lose value due to use or market conditions, and 3) the borrower will not impede the lender in moving forward to repossess the property. In a perfect world, this can be done. In the real world, unfortunately, it doesn’t happen all that often.

For these and other reasons (including federal regulations), lenders do not take back deeds in lieu of foreclosure very often nowadays. Problems such as judgment liens, second mortgages, homeowner’s association liens, and other miscellaneous title issues complicate the matter further. In addition, federal regulations often demand that the lender foreclose before attempting to collect from the debtor, in order to get as much value as possible out of the property.

And so we come to the principal advantage of the deed in lieu of foreclosure.  If and when a lender is willing to accept one, in most cases there is a release on the debt.  This is the reason the borrower seeks to have the lender take back the property: so that he can be get rid of his debt. However, these kinds of transactions have not been very frequent in the last few decades, due to lack of equity in properties being foreclosed.

If you can get a deed in lieu of foreclosure accepted when you wish to give the property back to the lender, it is often the quickest and most efficient way to resolve what can be substantial debt involved in owning real estate. If problems arise, a good lawyer can help sort them out.