What is a deed in lieu of foreclosure?

 

 

A deed in lieu of foreclosure is a transaction in which an owner in default, and about to be foreclosed, grants ownership of the property to the lender, as payment for the debt. The value of the property serves as debt payoff. As such, the owner no longer owes anything to the lender. This article briefly explains why and how this happens.

 

To grant ownership of a property, without paying off the underlying debt, is “to deed a property”. The property owner “deeds” the property to the entity that “gets the deed”. The phrase “in lieu” means to accept or do something instead of something else. Foreclosure is the sale of a property to satisfy a debt. In this type of transaction, the owner satisfies the debt to the lender by deeding the property instead of by foreclosure. Instead of exercising foreclosure, the lender gets the deed. Thus, the term “deed in lieu of foreclosure”.

 

Another name for “deed in lieu of foreclosure” is “estoppel deed” or “deed by estoppel”. Estoppel is a legal term. In an estoppel, a previously taken action precludes other present or future actions. Once having a estoppel deed, the lender can’t foreclose the property owner. This is because the lender took the action of accepting ownership of the property as satisfaction for debt. The lender is now “estopped” from foreclosing the owner.

 

Deeds in lieu of foreclosure most often take place when the value of the property is equal or higher than the value of the debt. In other words, when there is some equity. In some instances, the homeowner gets some compensation. This is usually just enough to make things happen. Otherwise, the lender will be better off carrying out the foreclosure process. Generally, by the time this arrangement is agreed upon, the owner is out of time and with no better alternative.

 

The following example will help illustrate the concept. A homeowner owes $250,000 and is a few days from being foreclosed. The property is worth $300,000. There is $50,000 of equity. If there were enough time to sell the property, the homeowner would earn $50,000. However, as it is, with the tight time frame, nobody will offer full price. At this rate, chances are that the homeowner will be foreclosed and get nothing. As an amiable alternative, the lender offers the homeowner $10,000 in exchange for the deed. This way the debt is paid off and the homeowner recovers part of the equity.

 

Typically, only private parties or smaller lending institutions directly owning the debt accept deeds in lieu of foreclosure. In most instances, this type of transaction is impractical for larger institutions. For the most part, large institutions just service debt held by large portfolio investors. Because of their size, legal limitations and relative inflexibility, these institutions tend to be better off foreclosing.