A Deed in lieu of foreclosure is a deed instrument in which a mortgagor (i.e., the borrower) conveys all interest in a real property to the mortgagee (i.e., the lender) to satisfy a loan that is in default and avoid foreclosure proceedings.
The deed in lieu of foreclosure offers several advantages to both the borrower and the lender. The principal advantage to the borrower is that it immediately releases him from most or all of the personal indebtedness associated with the defaulted loan. The borrower also avoids the public notoriety of a foreclosure proceeding and may receive more generous terms than he would in a formal foreclosure. Advantages to a lender include a reduction in the time and cost of a repossession, and additional advantages if the borrower subsequently files for bankruptcy.
In order to be considered a deed in lieu of foreclosure, the indebtedness must be secured by the real estate being transferred. Both sides must enter into the transaction voluntarily and in good faith. The settlement agreement must have total consideration that is at least equal to the fair market value of the property being conveyed. Generally, the lender will not proceed with a deed in lieu of foreclosure if the current fair market value of the property exceeds the outstanding indebtedness of the borrower.
Because of the requirement that the instrument be voluntary, lenders will often not act upon a deed in lieu of foreclosure unless they receive a written offer of such a conveyance from the borrower that specifically states that the offer to enter into negotiations is being made voluntarily. This will enact the parol evidence rule and protect the lender from a possible subsequent claim that the lender acted in bad faith or pressured the borrower into the settlement. Both sides may then proceed with settlement negotiations.
Neither the borrower nor the lender is obliged to proceed with the deed in lieu of foreclosure until a final agreement is reached.
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What is the process all about?
The process involves the signing of legal documents - the Agreement in Lieu of Foreclosure and a Warranty deed, quit claim deed or a grant deed. The first document reveals the terms and conditions of the deed-in-lieu, and is signed by both the lender and borrower. The second document, which is the deed, conveys legal ownership of the property to the lender.
The lender marks the borrower's note as "paid" and provides the latter with two forms - one which states that the debt is cancelled and the other which refers to the waiver of the right to a deficiency judgment (the lender's right to ask for the unpaid debt amount if it is not recovered totally by the property-sale).
The agreement for deed-in-lieu is executed through an escrow company which receives the borrower's note (marked as "paid") from the lender. The escrow then records the deed used for transferring legal ownership of the mortgaged property and sends the note to the borrower. The borrower is thus released from the liability of the mortgage payments.
Does a borrower need to pay tax in the process?
Once a borrower gets a release from the loan, he needs to pay the deed tax on account of the deed in lieu. In this process, if the lender cancels the debt, the deed tax is calculated on the basis of the unpaid loan amount along with any accrued interest which is forgiven. However, if the borrower goes for a deed-in-lieu and pays a certain amount towards the unpaid debt, the extra cash serves to reduce the amount of unpaid debt which is the basis of the deed tax.
It may happen, that the lender pays the borrower a certain sum of money in return for the deed-in-lieu when there is some equity in the property. In such a case, the cash offered to the borrower is added to the unpaid debt in order to determine the basis of the deed tax.
A deed-in-lieu may have a negative affect on a borrower's credit report thereby lowering his score. Even then, it has certain advantages both for the borrower and for the lender. Most often, the borrower gets the chance to free himself from the indebtedness associated with the loan. And, at the same time, he can avoid foreclosure which has greater negative impact compared to a deed-in-lieu. The lender, on the other hand, can avoid spending his time and money in completing the foreclosure.
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