This month we provide a brief overview of whether a property owner facing foreclosure should consider giving the property back to the lender through a deed in lieu of foreclosure. If the property owner is willing to let go of the property, the lender may be willing to accept a deed for the property from the owner instead of going through with a foreclosure sale. This is known as a “deed in lieu of foreclosure.” Property owners facing foreclosure should be aware that it may be possible for them to avoid some negative consequences of foreclosure if they are willing to give the property to the lender before the foreclosure sale.
A deed in lieu of foreclosure is a transfer of title in real property from the property owner/borrower to the lender in order to avoid foreclosure entirely or to stop the foreclosure process. The deed in lieu of foreclosure consists of an agreement between the borrower and lender that is negotiated after the possibility of a foreclosure arises. Such an agreement cannot be part of the original loan documents. That is, the lender cannot agree in advance that it will accept a deed in lieu of foreclosure. Thus, borrowers cannot create a contractual obligation at the time they borrow money that would allow them to force a lender to accept the property instead of going through the foreclosure process.
Lenders cannot force borrowers to surrender a deed in lieu of foreclosure, as this would infringe on a borrower’s rights. An agreement to accept a deed in lieu of foreclosure must be negotiated between the borrower and the lender. The HAFA program provides for a deed in lieu process if a loan modification fails. However, a borrower faced with losing property through foreclosure cannot simply execute and record a deed granting the property to the lender. If a borrower attempts to do this, the lender will record a “Notice of Nonacceptance,” which provides legal notice that it has not accepted the deed in lieu of foreclosure.
A senior lienholder may not want to accept a deed in lieu of foreclosure. If the property owner has other liens against the property, such as a second mortgage or judgment liens, a senior lender who accepts a deed in lieu of foreclosure accepts the property subject to those other liens. A foreclosure, on the other hand, will wipe out any junior liens (a junior lien is one that is recorded after the lien foreclosed upon). It may be more economically advantageous, therefore, for the lender to go through the foreclosure process. Other reasons that a lender may not wish to accept a deed in lieu of foreclosure include the risk that the borrower may seek to set the deed aside and the risk that a borrower’s creditors may claim that the deed constitutes a fraudulent conveyance. Lenders generally do not face these risks if they proceed with the foreclosure.
Even if the lender is willing to accept a deed in lieu of foreclosure, it may not be in the borrower’s best interest to execute the deed. If the property is worth more than the amount owed to the lender, a deed in lieu of foreclosure results in the borrower waiving any right to the excess proceeds from the sale of the property. It is rare in this economic climate that a property is worth more than what is owed on it, but there is another situation where a borrower may benefit from a foreclosure. If a borrower has more than one loan against the property, for example, a foreclosure sale may result in a junior lien holder receiving part of the money owed. In some situations, payment through foreclosure of part of the money owed to a junior lien holder may prevent that lien holder from seeking a deficiency judgment.
To illustrate, assume that a borrower owes $150,000.00 on a first mortgage and $50,000.00 on a second mortgage. Assume also that the property that secures these mortgages is worth $175,000.00. If the property sells for $175,000.00 at the foreclosure sale, the second mortgage holder will receive $25,000.00 (for purposes of this illustration, assume that foreclosure costs are negligible). The fact that the second mortgage holder receives some payment through the foreclosure will prevent it from obtaining a deficiency judgment. Of course, if the second mortgage is a purchase-money mortgage no deficiency judgment is available anyway. (See the September 2009 Courtside Newsletter for further discussion of purchase-money and non-purchase-money loans at www.glawgroupapc.com.) Nonetheless, there may be circumstances under which the borrower benefits from a foreclosure sale.
A deed in lieu of foreclosure, however, may create a significant benefit to a borrower. If the lender agrees to accept a deed in lieu of foreclosure, a borrower can minimize the injury to his or her credit. Further, a lender may agree to cancel the debt and forego any claims to recover a deficiency in exchange for a deed in lieu of foreclosure. The lender benefits by avoiding the costs of foreclosure, including costs associated with a delay in recovering the property. Under the right circumstances, a deed in lieu of foreclosure can be a win-win situation for both the borrower and the lender.
As discussed above, a number of factors must be considered in determining whether to execute a deed in lieu of foreclosure. As with all legal issues, it is important to consult a qualified legal professional in order to understand all of the risks and benefits associated with such action.
The author of this month’s newsletter is J Niswonger, an attorney with The GIARDINELLI LAW GROUP, apc. Mr. Niswonger may be reached at [email protected] or 951/ 245-9163.