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What is a Deed in Lieu?

A Deed in Lieu is when the property is deeded back to the lender with the approval of the borrower prior to foreclosure. (This process may still leave a negative impact on the borrower’s credit). The Deed In Lieu is typically used to satisfy a loan in default or to avoid foreclosure. To be considered a Deed In Lieu, the debt must be satisfied by the real estate being transferred. The transaction must be entered by both parties in voluntarily and in good faith.

This process provides several advantages for the borrower and lender. For the borrower it immediately removes his obligation to pay the debt on the loan. It also avoids the public disclosure requirements of a foreclosure and may allow them to get more favorable terms, while having less impact of their credit rating than a typical foreclosure. For the lender, it speeds up the time, cost, and negative risks that might happens during repossession.

Deed In Lieu Process

Just like with a short sale, the first step in obtaining a deed in lieu of foreclosure is for the borrower to request a loss mitigation package from the lender. The application will need to be filled out and submitted along with documentation about your income and expenses including:

  • a financial statement, in the form of a questionnaire, that provides detailed information regarding monthly income and expenses
  • proof of income
  • most recent tax returns
  • bank statements
  • a hardship letter
  • Listing the property for sale. The lender will also most likely require that you try to sell your home for at least 90 days before it will consider accepting a deed in lieu, and will require a copy of the listing agreement as proof that this has been done

Once these documents are completed, they are submitted to the lender.

Legal Agreements

The borrower and lender must sign several legal agreements, including the Agreement in Lieu of Foreclosure and a deed. The Agreement in Lieu of Foreclosure sets out the terms and conditions of the deed-in-lieu. The Deed conveys legal ownership of the property from the borrower to the lender.

The lender provides the borrower with documentation that the debt has been cancelled and that they waive their right of deficiency judgment in consideration for the Deed in Lieu

Tax Consequences

At closing, the borrower may be responsible for paying the Deed Tax and Income Tax On Cancelled Debt

Deed Tax: Since this deed involves the transfer of property, the borrower may need to pay a state deed tax on conveyance of property to the lender. The tax is calculated on the difference between the fair market value of your property and your mortgage balance plus any liens removed from the property due to the deed in lieu.

Income Tax on Canceled Debt: Until 2012, the Mortgage Debt Forgiveness Tax Relief Act relieves any income tax on canceled debt resulting from a deed in lieu. However, a borrower will need to satisfy certain conditions for mortgage tax relief. Once the Mortgage Debt Forgiveness Tax Relief Act expires, the borrower will face the original obligation to pay taxes on the cancelled debt.