How a Lawyer-Negotiated Deed in Lieu May Protect Your Credit

What Is a Deed in Lieu of Foreclosure?

A deed in lieu is a voluntary agreement in which the homeowner transfers ownership of the property to the lender or its designee instead of forcing the lender to complete foreclosure. The transaction requires both parties' consent:

• •The homeowner agrees to transfer the property.
• •The lender agrees to accept it.
• •The written agreement establishes what happens to the mortgage debt.
• •The parties can address the remaining balance, deficiency liability, possession, relocation assistance, subordinate liens, and final credit reporting.

This is different from foreclosure. In a foreclosure, the homeowner does not voluntarily convey the property under a negotiated agreement. The lender completes the applicable legal or power of sale process to terminate the homeowner's ownership.

The Consumer Financial Protection Bureau describes a deed in lieu as an arrangement in which a homeowner voluntarily turns over ownership to the lender to avoid foreclosure. It also advises homeowners to ensure that the transaction covers the entire amount still owed and to obtain any deficiency waiver in writing. That written agreement is critically important. A homeowner should not transfer title based on an assumption that the lender will automatically cancel the entire debt or report the account favorably.

Why Traditional Deeds in Lieu Can Seriously Damage Credit

A traditional deed in lieu often follows months of missed payments. The mortgage history may show:

• •30 days late
• •60 days late
• •90 days late
• •120 days late
• •Continuing serious delinquency
• •A final deed in lieu or other derogatory account notation

Those late payments can cause substantial credit damage before the lender ever accepts the deed. Consequently, people often attribute all of the resulting damage to the deed in lieu itself. But the credit report may reflect two related events: the borrower's extended history of missed payments, and the final disposition of the mortgage through a deed in lieu. That distinction matters. A deed in lieu completed after a year of missed payments does not create the same credit history as one completed while the borrower remains current.

Starting While Current Changes the Credit Analysis

Suppose a homeowner begins the deed in lieu process before missing a payment and remains current until the transaction is completed. In that situation, the mortgage history should not contain 30, 60, 90, or 120 day late payment reporting because those delinquencies never occurred. The homeowner is not asking the lender to forgive a year of missed payments. The homeowner is offering an immediate, orderly transfer of the property while continuing to perform under the loan.

Current servicing guidelines recognize that at least some homeowners may be evaluated for a deed in lieu before becoming seriously delinquent. For example, Freddie Mac's current servicing requirements provide a process for evaluating borrowers who are current or less than 60 days delinquent when the servicer determines that the borrower faces an eligible non retention imminent default. This does not mean every current homeowner will qualify. Eligibility depends on the owner of the loan, the servicer's authority, the borrower's hardship, the property, title, occupancy, finances, and applicable program rules. Nevertheless, the guidelines demonstrate an important point: a homeowner does not necessarily have to accumulate months of late payments before pursuing a deed in lieu.

What Is the Homeowner Offering the Lender?

The homeowner is offering the lender a chance to take the property back now, in broom swept condition, while the homeowner is still current on payments. That is the offer. Now compare it to what happens if the homeowner does not hand the property back now:

• •The lender loses approximately a year's worth of mortgage income while the foreclosure runs its course
• •The property will not be vacant for a year. It will be maintained, or it may have a renter in it, so the lender will not get possession for a long time
• •The property could decline another 5 to 10 percent in value during that year
• •The lender might have to pay cash for keys to convince the homeowner to leave at the end
• •The time value of money means a dollar received now is worth more than a dollar received a year from now

This is why the servicer should inform the investor that they ought to take this deal. The investor should also be reminded that because the homeowner is properly represented by a California attorney, the investor will not be able to go after the homeowner for a deficiency. In many cases the homeowner will not even have tax liability. So this is really about the homeowner exchanging a year's worth of rent free living in exchange for the lender not damaging their credit and reporting that they took the property back in full, without a damaging remark.

In many cases the lender does not even realize they are not getting the property back "in full" because this is not a short sale. There is no final selling price shown to the investor, and no selling costs deducted from the proceeds. The property is simply transferred back directly, and the agreement controls how the debt is reported as resolved.

The Credit Negotiation

The homeowner's position can be stated directly:

I am not giving you this property now because you can necessarily collect a deficiency from me after foreclosure. I am not giving it to you because foreclosure necessarily produces a worse tax result for me. I am offering it now because I want to resolve the loan without accumulating late payments and without an unnecessarily damaging final credit report. If you want the immediate benefit of a voluntary transfer, you must accept the property in full satisfaction of the debt, release me from further liability, report a zero remaining balance, and agree to acceptable final reporting of the mortgage account.

This is not a request to report false information. It is a negotiation over the legal and financial terms upon which the lender agrees to accept the property. There is no third party short sale purchase price. The property has not been sold to a buyer for a stated amount that is less than the mortgage balance. The lender is agreeing to take title directly and can agree to accept the property in full satisfaction of the obligation.

The deed in lieu agreement should therefore address the lender's final furnishing of the account, including:

• •The reported outstanding balance
• •Whether the debt is reported as fully satisfied
• •The account status after completion
• •The effective completion date
• •The final account remark
• •Whether the lender will use language suggesting that the debt was "settled for less"
• •When the lender will update its reporting
• •How any previous reporting errors will be corrected

The objective should be the most favorable accurate reporting the lender will agree to provide, ideally reflecting a current loan resolved through an agreed transfer, accepted in full satisfaction, with no remaining balance.

The Final Credit Remark Is Not an Afterthought

Credit reporting should be negotiated before the homeowner signs and delivers the deed. Once the lender has received and recorded the deed, the homeowner has surrendered the transaction's principal source of leverage. It is much harder to negotiate the final reporting after the lender already owns the property.

The agreement should not merely say that the lender will comply with applicable law or report the account accurately. Those general statements do not tell the homeowner how the lender actually intends to report the completed transaction. The attorney should seek specific written terms governing the final account status and remark.

Fannie Mae's current underwriting guidance confirms why the reporting matters. Desktop Underwriter can identify a deed in lieu through specific remark codes associated with the mortgage tradeline. The future lender may then be required to determine whether the applicable waiting period has expired. The information furnished by the existing lender can therefore affect how a future underwriting system identifies and evaluates the event.

The Deficiency Release Is Equally Important

Credit reporting is only one part of the transaction. The final agreement should also provide that:

• •The lender accepts the property in full satisfaction of the mortgage obligation.
• •The mortgage balance is reduced to zero.
• •The lender waives any deficiency.
• •The borrower is released from all further personal liability.
• •The lender will not sell or assign any alleged remaining balance.
• •The lender will not pursue a collection action after accepting the property.
• •Any applicable subordinate liens are resolved or separately addressed.

The recorded deed alone may not answer all these questions. The operative protection should appear in the written deed in lieu agreement, approval letter, deficiency waiver, or other enforceable closing documents. For qualifying Fannie Mae Mortgage Releases, the current Fannie Mae Servicing Guide generally requires a deficiency waiver upon successful completion, subject to the applicable mortgage insurance requirements. The homeowner should nevertheless verify that the actual documents provide the promised release.

Fannie Mae

• 4 years following a deed in lieu
• 2 years with qualifying extenuating circumstances
• 7 years following a completed foreclosure

Freddie Mac

• 48 month recovery period for a deed in lieu
• 24 months with qualifying extenuating circumstances
• 84 month period for a completed foreclosure