Deed-in-Lieu of Foreclosure: How Does It Work?
A Deed-in-Lieu of Foreclosure (DIL), which is the commonly used term for Deed-in-Lieu of Foreclosure, is a home disposition option in which a mortgagor voluntarily titles collateral property (your home) in exchange for a release of all obligations under the mortgage.
An interesting misconception about a foreclosure DIL is that many people feel that they can return the house to the bank at any time, without meeting any qualifying criteria. This is not true.
There are two main criteria that must be met before banks will accept a DIL, rather than go through the foreclosure process of repossessing a home. First of all, there cannot be a second mortgage held by a bank other than the bank that holds the first mortgage. Think about it. In a DIL situation, the house can only be delivered to a bank. This is, of course, the bank that has the first mortgage. Therefore, if there is a separate bank that has a second mortgage, they will not accept a DIL because they will receive nothing and will take a total loss on their loan. If the bank holding a second mortgage does not agree to a DIL, neither will the bank holding the first mortgage.
The second common misconception about a deed as opposed to a deed is that a homeowner who wants to vacate their home, perhaps because the home is worth much less than it is owed, can easily do so through a DIL. The homeowner often thinks the bank will agree to this, as it will save them many thousands of dollars by not going through the entire foreclosure process.
Unfortunately, this is not the case for homeowners who are not in financial difficulty. Banks will generally not accept a deed in lieu of a deed unless the homeowner cannot verify their mortgage payment. Typically, a homeowner will be behind on several monthly mortgage payments and will present financial documents showing that he cannot make his mortgage payments, before a deed-in-lieu of foreclosure will be considered by a bank.
The benefit of getting a DIL for the homeowner who has only one mortgage and cannot make the monthly mortgage payments is that the DIL allows them to get out of the house without a foreclosure on their credit report. The homeowner will still have late payments on their credit history, but it is much easier to recover from a DIL and then get another home loan than a foreclosure.
As mentioned above, the benefit to the bank is cost savings. It costs an average bank about $50,000 to go through the entire foreclosure process. Those lawyers are expensive! So if the bank can avoid most of the foreclosure fees, and after exploring all options, believes that a DIL is in the best financial interest of the bank, then it will grant a DIL.
Please note that the DIL option should only be considered by homeowners who have already explored all possible options to keep their home. It is rarely the best option and is typically only used when a homeowner must make a decision to file for a DIL or let the home go through foreclosure proceedings.