To Avoid Foreclosure, Which Should I Do: Deed in Lieu? Or Short Sale?

OK, it’s decision time. You’re dealing with financial challenges: a breakup, employment shakeups, or just too much debt against your property. You hold a deed, but can’t keep up with your housing costs. And you definitely want to avoid having a foreclosure on your credit history.

What should you do now? A deed in lieu of foreclosure? Or perhaps a short sale?

First, know that lenders tend to prefer short sales. A short sale in a time of high property values might take care of a deed holder’s entire mortgage debt.

Granted, pulling off a short sale takes a good deal more time than a deed in lieu. But with a deed in lieu, you give your home to the lender. This is a last-resort alternative to foreclosure.

With that introduction, let’s walk through a Q&A.

First, Should Foreclosure Be Avoided at All Costs?

A foreclosure hits a credit profile harder than its alternatives. But not by much. And foreclosure gets the job over and done. That said, foreclosure is an expensive, time-consuming, and all-around unpleasant experience.

So, first, are you sure your situation is as serious as you think it is? Perhaps the lender would extend a repayment plan, or modify your loan. Talk to the mortgage company and be sure you understand your range of options.

If you decide to try to avoid foreclosure, ask the mortgage servicer for a loss mitigation application. It will be a short sale request, or a deed in lieu request. You’ll submit tax returns, account statements, and details of your monthly income and expenses.

But what’s the better form of mitigation: deed in lieu, or short sale? Let’s take a brief look at each of these, along with their pros and cons.

A Short Sale: Often the Best Way Out of Debt

If you see pre-foreclosure sales, that means the deed holder is attempting a short sale. How does it work?

A deed holder falls behind on a mortgage debt and goes into a  default situation. A short sale could be the best way out of the jam. So the deed holder submits a statement declaring:

• The property value falls short of the mortgage debt.

• The deed holder lacks other assets to liquidate.

When you apply to a lender to do a short sale, you’re responsible for selling your home. This leaves you with more control than you’d have if you just let a foreclosure happen.

Struggling to find an offer high enough to pay off your loan balance? This setback is actually progress when you’re applying for loss mitigation options. If you can find a buyer, but the sale won’t cover the full mortgage balance, this would be a short sale.

In short sales, buyers generally fund the inspection and repairs. But it’s best to keep your home in good shape, and get a decent bid. Your short sale depends on lender approval — and your ability to actually sell your home.

Assuming your lender agrees to the terms of the sale, you’ll market the home and go to the closing. Your lender will get the sale proceeds and release its lien from the home title. Then you’ll transfer your deed to the buyer.

What’s the Main Downside to a Short Sale?

Do you have other debts secured by your home? Perhaps an HOA lien, a second mortgage against your home equity, or a judgment lien? The lienholders will have to green-light any sale. They’ll only do that if they think there’s some advantage for them. So, your mortgage lender will likely need to offer incentives to your other creditors.

And if you can pull off a sale, here’s what could be the worst rub. Depending on state law, a deed holder could face a deficiency judgment. That is, if the sale doesn’t satisfy the whole debt, your lender can go after a personal judgment against you.

Will the lender provide a written waiver of any deficiency in your short sale agreement? Watch closely. You might do better to let the home go into foreclosure if that lets you out of a big deficiency debt.

Deed in Lieu: When the Lender Takes Your Deed

In French, lieu (pronounced loo) means place. So, in lieu of means in place of. With a deed in lieu, a lender accepts your deed in place of foreclosure proceedings. You transfer your home’s title to your lender in return for a mortgage release. 

Remember, this is the transfer of last resort. For deed holders who lack home equity, it’s a way to let go of a home that’s become too much of a financial burden.

When the deed in lieu process concludes, you’ll likely transfer your title with a quitclaim deed. A lender may consider accepting your quitclaim instead of foreclosing once your real estate agent shows records that your home’s been marketed for several months.

Here again, you’ll fill out a hardship affidavit. Following the lender’s approval, you’ll receive a deed to sign and transfer to the lender. You’ll get a statement explaining the terms. You’ll sign, to show you agree with the terms. Look for the text saying your deed transfer satisfies the debt fully. If, instead, your lender reserves the option of pursuing a deficiency judgment, what then? Before signing the statement, ask the lender to forgive or reduce your deficiency. Remember that a foreclosure with no deficiency judgment might be preferable to a deed in lieu in this aspect.

On the other hand, with the deed in lieu, a lender may grant you more time in your home than a foreclosure eviction would allow.

Indeed, there’s no eviction with a deed in lieu. You are letting go of your deed voluntarily. Your lender may let you buy time by renting the home to you while you prepare to move. Why would the lender agree? Because banks are not fans of foreclosing. Some will help borrowers who want to avoid foreclosures.

What’s the Main Downside to a Deed in Lieu?

The deed in lieu comes with a number of drawbacks:

• With a deed in lieu, you’re handing your home over to the lender. That’s the main downside.

• In some states, the deed holder may face a deficiency judgment. If the home can’t satisfy the whole debt, a personal judgment may be filed against you for the rest.

Facing a deficiency judgment? In some cases, a bankruptcy filing makes sense. Consult a bankruptcy lawyer to learn more.

And most lenders won’t agree to take your deed in the first place if there are other debts (like tax liens, construction liens, court-ordered liens, or HOA liens) tied to the home.

I Need to Get This Debt Behind Me. Where Do I Start?

Speak to your lender about a loss mitigation application. The lender will ask you to submit a hardship statement, backed with proof of your financial situation and recent tax returns. Set forth in writing any serious change of circumstances you’ve facing — a divorce, a job disruption, or medical needs. In these situations, after a deed in lieu or short sale, you could apply for a conventional loan again sooner than the standard seven-year bar if you let the home go into foreclosure. FHA loans are generally available sooner (three years after a foreclosure or any of its alternatives). 

Remember to ask if the lender helps borrowers who seek new housing after averting foreclosure. In any case, keep your long-term housing needs in mind. For instance, try to have a rental home set up before the loss mitigation activity shows up on your credit profile.

Need more information? Check the IRS website for its latest foreclosure and debt forgiveness instructions. And set up a consultation with a local foreclosure attorney for specific guidance that suits your own situation.

Looking for help and support? An approved counselor can offer individualized guidance. Contact a housing counselor in your area. Help may also be available through a local legal aid firm, or from your state’s homeowner assistance resources.

Avoiding foreclosure is no easy feat. But many deed holders have done it, then rebuilt their credit. Knowing the pros and cons of your options helps you get on the best path forward.