What Is a Deed in Lieu of Foreclosure?

Foreclosure document with set of keys on top.
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Sometimes called the "friendly foreclosure," the deed in lieu of foreclosure involves the borrower voluntarily turning over the property to the lender to avoid foreclosure proceedings. While the property owner loses the property in either case, the borrower avoids the embarrassment and drama of a formal foreclosure.


Understanding Foreclosure

When a buyer purchases real estate and uses the property as collateral to secure a loan, the lender may turn to the legal process of foreclosure to sell or obtain the property if the buyer defaults on the loan. Three basic foreclosure types include the judicial foreclosure, nonjudicial and strict foreclosure. The judicial foreclosure requires court action. No sale occurs in a strict foreclosure, as the property title goes to the lender after fulfilling the necessary legal requirements.


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Deed in Lieu

To avoid the embarrassment of a foreclosure and get the experience behind them, some property owners opt for a DILF when they know foreclosure is inevitable. This requires an agreement between both the borrower and lender, and the borrower typically instigates the agreement. The borrower releases title to the lender to satisfy the loan, and vacates the property.

Lender Pros and Cons

Lenders don't always agree to accept a DILF. By accepting the friendly foreclosure, the lender may be forfeiting some rights afforded it by a formal foreclosure, such as possible VA guarantees or private mortgage insurance claims. If the foreclosure is inevitable, the lender may weigh the financial benefits of accepting the deed, which include avoiding foreclosure expenses and possible damages to the property during the eviction process.


Borrower Pros and Cons

While the borrower avoids the embarrassment of a foreclosure, a DILF can be just as damaging to the debtor's credit scores as a foreclosure, according to a report by Virginia Cooperative Extension. The lender typically requires the borrower pay for an appraisal and title search before agreeing. The title search is necessary to identify any other liens against the property. In some situations, it is possible for the lender to set aside the DILF if it discovers later that there were other liens against the property. Some lenders will not consider a DILF if the property lacks equity. In a foreclosure sale, if the property sells for an amount much higher than the loan balance, the borrower may receive a portion of the sale price, yet the borrower forfeits that right in a DILF. Before instigating a DILF, the property owner should consult with an attorney and accountant.