What Type of Foreclosure Is Sometimes Called Friendly Foreclosure?
Understand "friendly foreclosure," a cooperative mortgage solution offering homeowners a less adversarial way to address financial hardship.
When facing financial distress that impacts mortgage payments, homeowners often encounter the daunting prospect of foreclosure. This legal process, initiated by a lender to recover outstanding debt, can be lengthy and adversarial. However, alternatives exist that offer a more cooperative path, allowing both parties to resolve the situation outside of traditional court proceedings. One such option, characterized by its collaborative nature, is sometimes referred to as a “friendly foreclosure,” providing a structured way for homeowners to address their mortgage obligations without the full impact of a forced sale.
Understanding Deed in Lieu of Foreclosure
A Deed in Lieu of Foreclosure is sometimes called a “friendly foreclosure.” This process involves a homeowner voluntarily transferring the property deed to the mortgage lender. It serves as an alternative to formal foreclosure, releasing the borrower from mortgage obligations. This voluntary transfer is a last resort when other options, such as loan modifications or short sales, have been exhausted.
Unlike traditional foreclosure, which involves public auctions and extensive legal proceedings, a Deed in Lieu is based on mutual agreement between the borrower and the lender. This cooperative approach saves both parties considerable time and expense by avoiding litigation costs. It also offers the homeowner control over the timeline and avoids the public notoriety of a forced foreclosure.
Borrower Qualification and Lender Considerations
To qualify for a Deed in Lieu, borrowers must demonstrate genuine financial hardship. This includes job loss, reduced income, medical expenses, or divorce, making continued mortgage payments impossible. Lenders require detailed financial information, such as income, debts, expenses, tax returns, and bank statements, to assess repayment ability. A hardship letter explaining circumstances may also be required.
Property condition and market value are also important. Lenders prefer well-maintained properties, which increases marketability and resale value. If in disrepair, the lender might require repairs or reject the request. A clear title, free of additional liens (e.g., second mortgages, judgments, tax liens), is preferred. Some lenders may consider a Deed in Lieu if they hold all existing liens or if the borrower can resolve them.
Lenders accept a Deed in Lieu primarily to avoid the significant costs and time of traditional foreclosure. A Deed in Lieu allows the lender to gain control of the property more quickly and in better condition, reducing vandalism or neglect risks. While not obligated to accept, lenders may find it more cost-effective than full foreclosure, especially if property value is less than the outstanding loan balance.
Navigating the Deed in Lieu Process
Once a borrower is deemed eligible, the formal Deed in Lieu process begins. The initial step involves contacting the mortgage servicer to discuss loss mitigation options and submit a formal application. This application includes detailed financial documentation, such as proof of income and a financial statement.
Following application submission, the lender evaluates the property, including a Broker Price Opinion (BPO) or appraisal to determine market value. A title search identifies any other liens or encumbrances. If junior liens exist, the lender may require them cleared or decline the Deed in Lieu.
Upon successful evaluation and agreement, both parties negotiate the transfer specifics. This may include a “cash for keys” incentive, where the lender offers money for the borrower to vacate promptly and leave the property in good condition. The borrower then signs the grant deed, transferring ownership to the lender, along with an estoppel affidavit confirming the agreement’s voluntary nature and terms. The signed deed is then recorded, officially transferring ownership.
Post-Completion Considerations for Borrowers
After a Deed in Lieu is completed, borrowers face several important consequences. While generally less severe than a full foreclosure, a Deed in Lieu still negatively impacts the borrower’s credit score. The account will typically be reported as a settled debt rather than a paid-in-full account, and this negative entry can remain on credit reports for up to seven years.
One significant benefit of a Deed in Lieu is the potential for a waiver of deficiency judgment. A deficiency is the difference between the outstanding loan balance and the property’s value when the lender takes possession. Many Deed in Lieu agreements include a written provision releasing the borrower from personal liability for any remaining balance, which is a major advantage over a traditional foreclosure.
However, borrowers should be aware of potential tax implications if the lender forgives a significant portion of the debt. The IRS may consider the forgiven amount as taxable income, known as Cancellation of Debt (COD) income. While certain exclusions may apply, such as insolvency or the Qualified Principal Residence Indebtedness (QPRI) exclusion, borrowers should consult a tax professional to understand their specific tax liability. The Deed in Lieu will also affect future mortgage eligibility, requiring a waiting period of two to four years before qualifying for a new conventional loan. Government-backed loans like FHA or VA have specific waiting periods.