Transitioning into affordable housing is a top priority for many homeowners trying to recover from the mortgage crisis. Voluntarily giving up your home to the lender may beat going through foreclosure, but this option requires careful consideration. A deed in lieu of foreclosure conveys title to your mortgage lender in exchange for cancellation of the debt. Before agreeing to the terms of a deed-in-lieu, consider the pros and cons of this foreclosure alternative.
A deed-in-lieu's impact on your credit score is as severe as a foreclosure. The months of missed payments leading to the default and the act of settling an account for less than the amount owed diminish scores. Lenders typically report the account to credit bureaus as "not paid as agreed," according to My FICO. Although a deed-in-lieu affects scores as much as a foreclosure, many believe that creditors may consider it less severe than a foreclosure when evaluating you for new credit. A deed-in-lieu has less of an impact than bankruptcy, which affects several accounts. Giving up your home with a deed-in-lieu can relieve financial pressure that might otherwise cause you to file bankruptcy.
A deed-in-lieu may have tax consequences for the deficiency, or the amount unrecovered after the sale of the property. The IRS views the forgiven debt as income and may tax you on it. You must report the amount forgiven for the year in which you received the deed-in-lieu. The lender reports the exact amount on IRS Form 1099-C, which you receive in the mail after the deed-in-lieu. Borrowers who receive a deed-in-lieu for calendar years 2007 to 2013 may qualify for tax relief under the Mortgage Forgiveness Debt Relief Act of 2007. Qualified loans must have been incurred to buy, build or significantly improve a primary residence.
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Many lenders would rather receive money, albeit at a loss, than add another home to their inventory of foreclosed properties. They typically prefer to give loan modifications, which change loan terms to make them more affordable, or short sales, which allow you to sell your home at a loss in exchange for cancellation of the debt. It is difficult to get a lender to agree to a deed-in-lieu; often, you're required to market the property first, after which you may be offered a deed-in-lieu as a last resort. A lender may approve a deed-in-lieu to avoid the cost and hassle of foreclosing.
The federal government initiative Making Home Affordable has streamlined the process for seeking foreclosure alternatives. Its Home Affordable Foreclosure Alternatives, which is available through more than 100 participating lenders and loan servicing companies until the end of 2013, allows for a deed-in-lieu. Under the program, the lender promises to waive the deficiency amount and may offer monetary relocation assistance. Borrowers must meet specific guidelines, such as a qualified financial hardship, loan amount of $729,750 or less; and a loan origination on or before Jan. 1, 2009.