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What is a deed in lieu of foreclosure, and how does it work?

If you’re behind on your mortgage payments and believe you won't be able to catch up, you may want to discuss a deed in lieu of foreclosure with your lender.

A deed in lieu of foreclosure is an alternative to the traditional foreclosure process. Although it still negatively affects your credit score and overall finances, it can save you time and money compared to foreclosure.

Learn more: House deed — Definition, types, and how to get one

In this article:

What is a deed in lieu of foreclosure?
How does a deed in lieu of foreclosure work?
Pros and cons
Alternatives
FAQs

A deed in lieu of foreclosure (sometimes referred to simply as “deed in lieu”) is an arrangement in which homeowners transfer the title to their home to their mortgage lender in exchange for the lender relieving them of the obligation to continue making payments. Essentially, this means handing the keys to your home back to your lender so that both of you can avoid the expense and time associated with a foreclosure.

However, not every mortgage lender offers the option of a deed in lieu of foreclosure, and eligibility will depend on individual circumstances. In some cases, you may still be obligated to pay some of your debt. You could also generate a tax liability for the forgiven debt. If you’re struggling to make your mortgage payments, though, this could be an option to discuss with a housing counselor, a tax professional, and your lender.

A deed in lieu of foreclosure requires an agreement between you and your lender that you will vacate your house, and the lender will close your loan. The details will vary depending on your circumstances.

There’s no obligation for your lender to agree to a deed in lieu of foreclosure. But if the company is willing to work with you, it might allow you to live in the home long enough for you to make a new housing arrangement. If you’re underwater on your mortgage — meaning you owe more on the house than its appraised value — your lender may forgive some or all of the outstanding mortgage debt.

Another possibility is that your lender could offer you a “cash for keys” arrangement in which you would receive cash for relocation expenses.

Market conditions play a role in how willing a mortgage lender is to accept a deed in lieu of foreclosure. If the housing market is slow and the property may not sell for a long time, your lender is less likely to accept a deed in lieu of foreclosure than when homes sell quickly.

While each lender has different requirements for a deed in lieu of foreclosure, generally, lenders will need the homeowner to:

Have been delinquent on mortgage payments for a certain period of time
Provide evidence of financial hardship that makes repayment in the near future unlikely
Have unsuccessfully tried to sell the property
Have been unable to qualify for a loan modification

Lenders will also check that no other liens or debts are associated with the property, such as tax liens or a second mortgage. The property must be turned over to the lender in good condition. If your home is in satisfactory condition and your mortgage is less than the estimated value of your home, your lender is more likely to consider a deed in lieu of foreclosure than if your home has been poorly maintained.

Dig deeper: What to do if you have an underwater mortgage

Foreclosure is a legal procedure a lender can initiate when a borrower is behind on their mortgage payments. The specific rules vary by jurisdiction, but foreclosures can take months or even years and generate expenses for both the lender and the borrower. For the homeowner, that can mean a lack of clarity about their future and a delay in moving. A foreclosure significantly impacts the homeowner’s credit profile and is often public information.

A deed in lieu of foreclosure is a voluntary option that borrowers can request or that a lender can offer. The lender determines the agreement's details, which typically require the homeowners to move out on a specific date and leave the property in good condition. A deed in lieu of foreclosure is less public and normally faster than a foreclosure, allowing the homeowner to move on to repair their finances.

If you are behind on your mortgage payments, there are some advantages and disadvantages to consider before you agree to a deed in lieu of foreclosure.

Lower legal costs than with regular foreclosure. You work directly with your lender and may not need a lawyer or to go to court.
Less publicity. Foreclosure notices are typically posted at your home and published in a local newspaper. A deed in lieu of foreclosure can be accomplished privately with your lender.
Quicker resolution. If you don’t expect that you can keep your home for the long term, a deed in lieu of foreclosure can wrap up your situation faster than foreclosure.
Potential financial benefits. Depending on the rules in your state, you can negotiate with your mortgage lender to have any deficiency in the amount owed on the mortgage forgiven. The lender may be willing to negotiate other benefits, such as money to help you relocate.

Damage to your credit score. A deed in lieu of foreclosure will appear in your credit report, along with your history of late payments. How much will your credit score drop? It depends on your financial information, such as other past-due accounts. This could affect your ability to qualify for another mortgage in the near future, as well as other loans like auto or personal loans.
Waiting period. Once the deed in lieu of foreclosure process is complete, you will face a waiting period before you can buy a house again. Each lender and loan type works differently, but for mortgages backed by Fannie Mae, the period lasts two to four years. For FHA loans, the waiting period is three years.
Your lender may not approve it. It’s up to your lender’s discretion to agree to a deed in lieu of foreclosure.
You could owe more money. Even after a deed in lieu of foreclosure, you could be held responsible for any gap between the appraised value of the house and your mortgage balance. You may also owe taxes on any part of your mortgage that your lender forgives.

If you can sell your house for enough money to pay off your loan and move, that may be the best option to avoid damaging your credit. But if you want to keep your house, you should approach your home loan lender to discuss ways that you could catch up on past-due payments and begin a new payment plan.

A housing counselor can help you understand the possibilities available depending on your circumstances. You may want to contact a HUD-certified housing counselor to get advice about your options.

Here are some alternatives to a deed in lieu of foreclosure:

If you have a source of income or anticipate having income shortly, you may be able to negotiate one of several options with your lender. A loan modification is a new repayment plan that you and the lender agree to, such as a reduced monthly payment, a longer loan term, or a switch from an adjustable-rate mortgage to a fixed-rate one.

A loan modification will be less damaging to your credit profile than a deed in lieu of foreclosure and will allow you to keep your home.

Dig deeper: How to apply for a mortgage loan modification

If you need a short-term break from your payments, your lender may agree to forbearance, which allows you to stop making payments for a few months. Your lender must then agree to a repayment plan when you are ready to begin payments again. Like a loan modification, forbearance will be less damaging to your credit score and let you keep your home.

Keep learning: How to use mortgage forbearance to avoid foreclosure

If your home is worth less than you owe on your mortgage, you can negotiate for your lender to accept a short sale. In that case, the lender would cover the closing costs and potentially forgive the remaining mortgage balance, depending on local laws.

A short sale is typically listed as “settled” or “legally paid for in full for less than the full balance” on your credit report, which will likely lower your credit score.

Since foreclosure is a mandatory legal process instead of a voluntary option to give up your home, you may incur legal fees. A foreclosure will stay on your credit report for seven years and have longer-term, more severe financial impacts than many other options.

A homeowner might prefer foreclosure over a deed in lieu if they want to delay moving as long as possible. In some states, a foreclosure can take months or years to complete. Also, a foreclosure typically clears the homeowner of all debt repayment obligations — especially if you only have one mortgage loan — but not all deed in lieu of foreclosure agreements eliminate the obligation to repay a gap between the mortgage balance and the home's sale price. Still, choosing foreclosure is risky, so speak with a loan officer or financial advisor before deciding.

Bankruptcy may be required if you have unpaid debt in addition to your home. However, you may be able to keep your home if you can manage a repayment plan through Chapter 13 bankruptcy. Bankruptcy remains on your credit report for seven years and will impact your ability to obtain additional credit.

Learn more: Can you file for bankruptcy and keep your house?

Yes. Your credit score is likely to drop because a deed in lieu of foreclosure indicates that you could not repay your loan as promised.

While individual lenders may have different requirements for loan approvals, the waiting period to qualify for a conventional loan from Fannie Mae is four years after a deed in lieu of foreclosure, compared to seven years after a foreclosure. If there are extenuating circumstances, the waiting period can be as little as two years. FHA borrowers must wait three years after a deed in lieu of foreclosure before qualifying for a new FHA loan.

Possibly. If your lender forgives a portion of your loan balance as part of the deed in lieu of foreclosure agreement, that amount may be considered taxable income.

This article was edited by Laura Grace Tarpley.

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