Real estate analysts point out that foreclosure rates have been showing a downward trend since the subprime crisis. While this is correct, it is interesting to note that the number of foreclosures in 2016 were, in fact 30% higher than what they were in 2006. As of 2016, the number of foreclosure filings reached near a million! Certainly not a small number by any means.I hear more and more instances of banks offering a deed in lieu of foreclosure to the borrower.
So, what is this deed in lieu of foreclosure? Is it better than opting for a short sale or a foreclosure? How does a deed in lieu of foreclosure affect your credit score? And, is this deed advantageous to the lender, borrower or both?
A deed in lieu of foreclosure is a potential option taken by the borrower to avoid foreclosure. This deed is a title transferring document that releases the borrower from the mortgage. All rights for the property are transferred to the lender.
Many argue that a deed in lieu of foreclosure actually ends up benefiting the bank. Naysayers point out that a borrower is offered a deed in lieu of foreclosure as a last resort. This is after a loan modification or short sale has been rejected. Doing so enables the bank to forego costly foreclosure proceedings. If you still have some equity rolled into your home, you should, of course NOT opt for a deed in lieu of foreclosure.
Not really. Let me explain why.
Firstly, if you have a second lien on your home, deed in lieu of foreclosure is not really an option. Using a deed, you are transferring your property rights to the bank. If you have a two mortgage situation, the bank cannot really offer you this option since there are multiple lender claiming right over the property. Whereas in a short sale, the buyer is the one who settle the secondary liens. So, in a two mortgage situation, short sale is your go to option.
Secondly, it is common for the borrower to avail relocation incentives in a short sale. This is a huge advantage when you are in a cash crunch.
Do note that California is the only state with laws which prevent deficiency judgments against borrowers. For Deed in Lieu of Foreclosure, there are no such laws. And if the lender is not bound by a contractual agreement, he is likely to come after you for the deficiency balance.
Experts point out that opting for a deed in lieu of foreclosure might have the same impact on your credit as that of a foreclosure. According to FICO, a blown foreclosure will see your credit score drop by up to 160 points. If your credit score is 680, a foreclosure will drop your credit score on average by 85 to 105 points. If your credit score is excellent (780), a foreclosure will drop your score by 140 to 160 points. Higher the score, steeper the drop.
A foreclosure will remain on your credit report for a painfully long period of 7 years. If you observe prudent financial practices, your credit score can start showing improvement in 2 years.
So, is there anything that you can do to lessen the impact of deed in lieu? Well, if your lender does not report a deficiency balance, the blow to your credit score is somewhat softened. And this holds true for a short sale and foreclosure also.
Reason #1 A property need not be in foreclosure for a bank to offer you a deed in lieu. Under many circumstances, it is not profitable for the bank to go for a deed in lieu of foreclosure. How so? Well, they can make more money by foreclosing your property. In some cases the bank may receive financial incentives from government if it opts for a foreclosure.
Reason #2 If there is a lien attached to your property, the bank is less inclined to take over your property via a deed in lieu of foreclosure. Often PSA’s or Pooling and Service agreement guidelines might prohibit a deed. Sometimes the PSA may ask the borrower to furnish some capital – a prerequisite for the deed in lieu of foreclosure to kick in. And, it is quite possible that the borrower is not able to muster this required financing.
Reason #3 It might be possible that a deed in lieu is prohibited by a Pooling and Service Agreement or a PSA. What is a PSA? Well, your loan mortgage might get bundled into a mortgage based security to be sold to interested investors. PSA is a contract stipulating the right of these investors over your mortgage loan.
A deed in lieu of foreclosure is not really a viable option. The impact on your credit history (which is equivalent to that of a foreclosure), and the possibility of the lender coming after you to claim the deficiency amount are huge negatives. If you do consider this option, ensure that your contract clearly states that the lender is foregoing the deficiency amount.
Opting for a short sale presents significant advantages in comparison to a deed in lieu of infrastructure. This holds true especially when you own a two mortgage property. Referring to the other comparative advantages that I highlighted earlier, I strongly suggest you consider a short sale before a deed in lieu of foreclosure.