The Disadvantages of a Deed in Lieu of Foreclosure

A deed-in-lieu of foreclosure lets you walk away from a mortgage legally.

A deed-in-lieu of foreclosure lets you walk away from a mortgage legally.

When you have no chance of staving off an impending home foreclosure, a deed-in-lieu of foreclosure often looks like a good way to end your mortgage pain. This exit strategy lets you sign the deed to your home over to your mortgage company and drop off the keys when you decamp. While a deed-in-lieu frees you from your mortgage obligation, choosing this option has disadvantages that you should consider before taking the plunge.

Restrictions

The time limit for sealing the deal is 90 days, no matter how that affects your housing outlook or your schedule, according to the U.S. Department of Housing and Urban Development. Your mortgage company has to agree to accept a deed-in-lieu of foreclosure and draft all of the paperwork. You lose all control over your exit strategy from your home because you must accept the terms offered by the mortgage holder or else. Some states allow the mortgage company to sue you to get a deficiency judgment -- the difference between what you owed and the price that your house fetched after you split. If your deed-in-lieu contract doesn’t bar the lender from seeking a deficiency judgment, you can get a nasty surprise after you walk away from your home.

Second Mortgages

A second mortgage on your house complicates the deed-in-lieu of foreclosure process. You now have two lenders who must agree to take financial losses. The primary mortgage holder runs the show, but unless the second lender agrees to the terms of the deal, you have no deal. Federal government programs provide incentives to both the primary lender and the second lender, but under these rules, the maximum amount you can get in 2012 to entice the second lender is $2,000.

Taxes

The Mortgage Debt Relief Act of 2007 exempts you from tax on up to $2 million of forgiven mortgage debt, such as a deed-in-lieu of foreclosure or a short sale. However, unless Congress renews it, this law expires at the end of 2012. Even now, any part of your mortgage loan that you didn't use for buying the housing or home improvement is not eligible for mortgage forgiveness, according to the Internal Revenue Service. Funds from a refinance that you applied to credit card debt or used buy a car will show up on 1099-C income statement from your mortgage company at the end of the tax year. The IRS requires that you add the total amount on that 1099 to your annual income, which will usually increase your tax bill by a huge amount.

Credit Score

Your credit score automatically takes a hit when you opt for a deed-in-lieu of foreclosure. You stand to lose roughly the same number of points as you would for actual foreclosure, according to CNN Money. Scores drop 85 to 160 points once the major credit bureaus get wind of your choice. The higher your score when your mortgage trouble began, the more likely you are to see a bigger drop. You’ll be in a pickle when you try to find new housing, and a lower credit score can affect your future job and banking options.

About the Author

I was an editor for two non-profit newsletters. In 2007, I wrote more than 100 SEO How-to articles for WRG. I also recently completed a series of Workforce Development Mathematics test items for ACT. These projects are covered by Non Disclosure Agreements. However, I can provide references for them, if desired.

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