When you default on your mortgage, the bank has the right to pursue an expensive foreclosure process. Instead of fending off foreclosure, homeowners can choose to pursue a deed in lieu of foreclosure. This option is a legal document, notarized by a notary public and recorded in the public records, that transfers the title from the homeowner to the bank that initially possessed the mortgage.
Unfortunately, not all mortgage agreements allow for it.
A short sale is when you sell your house for less than your total debt remaining on your home loan. The bank is “shorted” because they have accepted the discounted payoff instead of the entire mortgage amount.
In the foreclosure timeline, the homebuyer usually requests a short sale during pre-foreclosure. However, the bank can deny a short sale request.
In lieu of foreclosure releases the borrower from their mortgage obligations. Some banks allow homeowners to walk away without needing to pay the difference between the money owed and the amount the lender can sell it for.
Additionally, the borrower also saves their credit score from the more damaging option of foreclosure. This option also usually benefits the bank as well because it helps the lender avoid the costs that come with pursuing a foreclosure.
Some banks will even offer a cash incentive for homeowners to opt for a deed in lieu of foreclosure. This cash incentive was nicknamed “cash for keys.”
While some banks may allow the homeowner to walk away without needing to pay the difference between the money owed and the amount the lender can sell it for, others may require homeowners to pay the difference during tax season.
Deed in lieu of foreclosure will impact you to buy another home for a time. Currently, Fannie Mae and Freddie Mac, two government-sponsored enterprises specializing in the secondary mortgage market, will not buy a mortgage from a borrower who signed a deed in lieu for four years without extenuating circumstances or two years with extenuating circumstances.
With a short sale, you may qualify to buy a new home within two years. However, after you sign a deed in lieu of foreclosure, you will likely need to wait at least four years before qualifying to purchase a new home.