The topic of foreclosure can be unpleasant to think about or discuss. However, for homeowners struggling to keep up with mortgage payments, it's a necessary discussion to have. Losing your home to foreclosure can be devastating; however, it might be necessary. Mortgage companies offer other options to avoid the foreclosure process, but losing your house affects your credit score no matter which path you take.
TL;DR (Too Long; Didn't Read)
Giving your house back to the mortgage company through the process of deed in lieu will ding your credit, but it generally doesn't lower your credit score quite as much as a foreclosure.
Deed in Lieu
A deed in lieu of foreclosure is one way for homeowners to avoid a foreclosure by willingly giving their home to the lender. Although it might sound like an easy way to get out of your mortgage loan by definition, it's actually more difficult in practice. You can't simply contact your lender and say you want to give your house to them because you can't afford the payments anymore.
Most lenders require that you attempt to sell the home first before they will consider a deed in lieu. Additionally, you'll need to prove that you're experiencing financial hardship such as a medical emergency or job loss.
Mortgage Foreclosure Process
When you attended your loan's closing, you signed many documents -- including the promissory note and the security instrument. By signing the promissory note, you acknowledged that you owe the lender the amount borrowed plus interest. The security instrument acts to secure the property itself as collateral.
If you stop making the mortgage payments, the lender can seek foreclosure and repossess the property. State laws determine when a lender can start the foreclosure process and whether a judicial ruling is required. The end result of foreclosure is the lender sells your home at a public auction to the highest bidder.
Effect on Credit Score
Both a deed in lieu and a foreclosure hurt your credit score. Being only 30 days late on your mortgage payments can cause your score to drop up to 110 points. It takes time to process deeds in lieu and foreclosures, and if you're not making payments during this time, your credit will continue to suffer. After either route is completed, the credit bureaus view it as loan default, and it remains on your credit report for a number of years.
The exact number your score drops depends on other factors, but on average a foreclosure can drop a credit score by as much as 160 points, and a deed in lieu can drop a credit score by as much as 125 points; some sources estimate the drop is even greater. According to Credit Sesame, the drop is usually more significant for those with high starting scores.
Deed in Lieu Potential Benefit
Although giving your home back to the mortgage company is likely to hurt your credit score just as much as a foreclosure would, it might look better than a foreclosure to a lender in the future.
- Realty Trac: Deed In Lieu: A Way Out of Foreclosure
- Bank of America: Deed in Lieu
- NOLO: Short Sales and Deeds in Lieu of Foreclosure
- Zillow: How Does Foreclosure Affect Your Credit Rating?
- NOLO: What's The Difference Between a Mortgage and a Promissory Note?
- Credit Sesame: Foreclosure and Deed in Lieu of Foreclosure - My Credit Score Took a Huge Hit. Now What?