During this Great Recession, as many as one in five American home owners have found themselves unable to keep up with their monthly mortgage payments.
The first line of defense for most of these folks has been to pursue a loan modification. However, since a loan modification is based on the borrowers ability to make mortgage payments, these transactions are not always successful.
The second line of defense for these folks is to sell their homes through the process of Short Sale. During the past year, many Century 21 M&M agents have achieved certification in the Short Sale process. Still Realtors and homeowners may experience the frustration of a long short sale process during which lenders often drag their feet and buyers give up and back out of the transaction.
Overall, a Short Sale is still the best choice for homeowners facing foreclosure.
However, if the process of a short sale fails, the homeowner may consider a ‘deed in lieu of foreclosure’. Simply put, the property owner gives the property to the lender, voluntarily, in exchange for the lender canceling the loan.
Typically a ‘deed in lieu of foreclosure’ proceeds in this manner:
- The homeowner and lender sign an Agreement in Lieu of Foreclosure which sets out the terms and conditions of the ‘deed in lieu’.
- The home owner and lender sign a deed, which conveys legal ownership of the property to the lender.
- The lender marks the borrower’s note as “paid” and provides the borrower with a document that states that the debt is canceled.
- The lender provides the borrower with another document that waives the lender’s right to a deficiency judgment (the lender’s right to ask for the amount of the debt they are unable to recover from the sale of the home).
- The agreement for ‘deed in lieu of foreclosure’ is executed through an escrow company which receives the borrower’s note (marked as “paid”) from the lender.
- The escrow then records the deed in the property’s file at the county recorder’s office and sends the note to the borrower, releasing the borrower from all obligations under the mortgage.
- Foreclosure is devastating to a credit score, almost anything is better than foreclosure, and results in a lighter impact on your credit score.
- The borrower is immediately released from most or all of the personal indebtedness associated with the defaulted loan.
- The borrower 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, lower risk of borrower revenge (metal theft and vandalism of the property before sheriff eviction), and additional advantages if the borrower subsequently files for bankruptcy.
The Cons of a ‘deed in lieu of foreclosure’ may include:
- A negative strike on the borrowers’ credit rating, however, it is less harmful than a mortgage foreclosure.
- The lender may not be willing to forgive the deficiency balance. It is important to read the contract carefully (or take it to an attorney) to see how the deficiency balance issue is handled.
- Since deed in lieu foreclosure involves the transfer of property, the borrower may need to pay a state deed tax on conveyance of property to the lender.
- The borrower surrendering a home to the lender may owe income tax on cancelled debt. However, under the Mortgage Debt Forgiveness Tax Relief Act (applicable till the end of 2012), you may not need not pay any income tax on canceled debt resulting from a deed in lieu, however, some borrowers do not qualify for this tax relief.
NOTE: It is important that you first consult with an attorney and/or a tax accountant in order to understand all of your options in resolving your mortgage debt.
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