Deed in Lieu of Foreclosure: What It Means and FAQs

If you’ve tried everything but just can’t make your mortgage payments anymore, you may be looking for ways to avoid foreclosure. In this situation, you might want to consider a deed in lieu of foreclosure.

This is an option that can be advantageous for both you and your lender.

Here, we’ll discuss what a deed in lieu is and how you should go about it.

What’s a Deed in Lieu of Foreclosure?

A deed in lieu of foreclosure is when you hand the deed back to your bank or lender instead of them going through the full foreclosure proceedings. The phrase “in lieu of” means “instead of.” Essentially, by handing the deed to your lender, you transfer the ownership of the house to them. This ensures that you avoid a foreclosure without having to sell the property yourself or negotiate a short sale. 

If you fall behind on your mortgage payments, or you see yourself falling behind in the near future, taking a deed in lieu allows you to leave your house gracefully without any large impact on your credit.

You can find a sample deed in lieu agreement on the SEC’s website.

What Is Foreclosure? 

Foreclosure is the legal process through which the lender takes possession of the borrower’s property. It’s done when the borrower is struggling to make mortgage payments and is defaulting regularly.

There are two different types of foreclosures:

• Nonjudicial Foreclosure – A lender will foreclose on the property without legal action. States such as California and Texas use a nonjudicial procedure unless a deed in lieu of foreclosure or other option takes place
• Judicial Foreclosure – The lender will take legal action to foreclose and seize the property. States such as Florida and Vermont will use a judicial procedure unless a deed in lieu of foreclosure or other option takes place.

Each state has different laws on how a foreclosure can and should occur. The deed in lieu is basically a nonjudicial foreclosure that is initiated by you instead of the lender.

Must Your Lender Accept a Deed in Lieu?

Unfortunately, your lender is not obligated to accept a deed in lieu. Your lender may also want to see that you tried other options, such as a short sale or a loan modification, before exploring the possibility of a deed in lieu. 

If your lender accepts your offer of a deed in lieu, it’ll usually also relieve you of any remaining mortgage debt after you transfer the ownership of the property back to the lender. 

However, it’s possible to still owe some balance on the mortgage after signing the deed in lieu agreement. This happens in a situation the lender doesn’t voluntarily waive the outstanding mortgage debt. Borrowers are advised not just to get their lenders to agree to a deed in lieu. They should also try to persuade the lender to waive what’s owed on the mortgage and express this in writing.

When both parties sign a waiver of the deficiency balance the lender can’t take legal action against the borrower for any debts that the borrower owes on the property. 

Some lenders may even give you a few thousand dollars to relocate if your home is in good condition. This is where the term “cash for keys” comes from. There may also be programs in place that will help you with finding a new residence. 

When Will a Lender Accept a Deed in Lieu of Foreclosure?

• Delinquency: How far you are already behind on your payments is going to be a significant factor in deciding if your lender agrees to your deed in lieu. If you have been consistently missing your mortgage payment over a substantial period, this will actually increase the chance they will accept your proposal.
• Mortgage Balance: If the house is almost paid off, or it is relatively low, they may be more willing to accept a deed in lieu because there is less risk to their bottom line. Since there is not much money left in the mortgage, they won’t want to risk spending more in legal fees to foreclose on the house than it’s worth.
• Resell Opportunity: In the case of a particularly good real estate market, a lender may accept a deed in lieu if it seems they can resell the house quickly. This is usually in cases when the market is booming, the home is in great condition, it’s a buyer’s market, and its property value is favorably proportional to the mortgage balance.

When Will a Lender Reject a Deed in Lieu of Foreclosure?

• Your Home Is in a Bad Condition: The condition a home is in is a huge factor when trading hands, no matter the circumstance. It’s also a huge factor when proposing a deed in lieu. This is because the condition of the residence impacts its value. If the condition of the home makes its value to be less than what you still owe on the mortgage, you may have a hard time convincing your lender to take it back without holding you responsible for the remaining debt.
• Delinquency: If you’re mostly caught up, or just one or two payments behind, they may be more hesitant. This is usually because they may believe that you can explore other options to keep making payments instead of going through the hassle of trying to resell the house.
• Mortgage Balance: If the balance of your mortgage is still relatively high, they may go ahead and foreclose on the house, because there is still a lot of money to be made on it. If they have recently purchased your mortgage note from another lender, they may not be so apt to accept a deed in lieu as well.
• Property Value: If the property is worth less than the balance on the mortgage, a lender may be more inclined to take a deed in lieu. For many of the same reasons as our last point, they may find difficulty reselling the home for more than it’s worth. If this is the case, they may not be interested in signing the relevant paperwork to cancel the debt on your behalf, however.
• Market Conditions: During the subprime mortgage crisis of 2008, many lenders were accepting deeds in lieu, due to the volatile landscape of the economy at the time. In times when the real estate market is slow or there is an economic downturn, lenders are more likely to accept a deed in lieu.

What Documents Do You Need to Sign a Deed in Lieu?

When signing a deed in lieu of foreclosure in the U.S., you’ll need to provide several documents. These help formalize the agreement, ensure that your lender accepts the property, and protect you from future liability. Here’s what each document does and why it matters:

Deed in Lieu of Foreclosure Agreement

This is the main document that lays out the terms of the deal between you and the lender. It confirms that you are voluntarily handing over your property to avoid foreclosure and outlines any conditions, such as whether the lender will forgive the remaining debt or if you’ll still owe money. Without this agreement, there’s no official transfer of ownership.

Grant Deed in Lieu or Quitclaim Deed

Once the lender agrees to take back the property, you’ll need to sign a Grant Deed or Quitclaim Deed to officially transfer ownership. A Grant Deed provides the lender with a clear title, meaning you’re guaranteeing that no one else has a claim on the property. A Quitclaim Deed, on the other hand, transfers whatever ownership interest you have, without making any guarantees about the title.

Estoppel Affidavit

This document serves as legal proof that you’re willingly giving up your rights to the property. It confirms that you understand what you’re agreeing to and that you’re not being forced into the decision. It may also include a statement that you have no other legal claims against the lender or the property.

Financial Documentation

Lenders typically ask for financial documents to determine if a deed in lieu is the best option for both parties. This may include:

• Bank statements to show your financial status.
• Proof of income (pay stubs or tax returns) to confirm your earnings.
• Monthly expenses to assess whether you can afford to keep making payments.

This information helps the lender evaluate whether they should approve your request or suggest a different solution, such as a loan modification.

Hardship Letter or Affidavit

A hardship letter is your chance to explain why you can’t keep up with mortgage payments. Maybe you lost your job, faced medical bills, or went through a divorce—whatever the case, this letter helps your lender understand your situation. Some lenders require a hardship affidavit, which is a formal, sworn statement about your financial difficulties.

Loss Mitigation Application

This is a form that lenders use to assess all available options for struggling borrowers. It includes details about your income, expenses, and any assets you own. Some lenders require you to fill this out before they approve a deed in lieu because they want to see if other solutions might work instead.

How to Request a Deed in Lieu of Foreclosure

Although a lender might reject a deed in lieu, you should still ask for it if you can’t pay the amount you still owe on the mortgage but you don’t want that to damage your credit. The process involves several critical steps which we’ve summarized below. 

• Contact Your Loan Servicer: Begin by reaching out to your loan servicer, the company managing your mortgage, to let them know that you’re considering a deed in lieu. Ask about their specific requirements and whether you qualify. Some lenders may require you to attempt selling the home before considering this option. 
• Complete a Loss Mitigation Application: Request a loss mitigation package from your lender, which includes necessary forms and instructions.
• Submit the Application: Ensure that all forms are completed accurately and include the required supporting documents. Submit the application promptly, following any deadlines set by your loan servicer.
• Await Lender’s Review: The lender will assess your financial hardship and determine if a deed in lieu of foreclosure is a viable option. They may also evaluate the property’s condition and check for any junior liens, such as second mortgages or unpaid property taxes, that could impact the transfer.
• Negotiate Terms: Discuss whether the lender will waive any remaining balance on your mortgage after the property is transferred.
• Sign the Agreement: If you qualify for a deed in lieu, you will sign a deed transferring ownership of the property to the lender. Ensure that all terms are clearly outlined in the agreement. You will also need to coordinate your move-out date and leave the property in good condition.
• Obtain Confirmation: Request written documentation from the lender confirming that your mortgage obligation has been satisfied. This document should specify the terms of the deed in lieu agreement and confirm whether any remaining balance has been forgiven.

Effect of a Deed in Lieu on Tax Liability 

A deed in lieu of foreclosure can have significant tax consequences, depending on your financial situation and the type of loan you had. Here’s what you need to know:

Forgiven Debt Might Be Taxable

If your lender forgives part of your mortgage debt after taking back your property, the IRS may consider the canceled amount as taxable income—this is known as Cancellation of Debt (COD) income.

For example, if you owed $200,000 on your mortgage but the lender accepted the property in exchange for settling the debt and it was worth only $180,000, that $20,000 difference could be reported to the IRS as income, meaning you might owe taxes on it.

Recourse vs. Non-Recourse Loans Matter

The type of loan you had determines how the IRS views the forgiven debt:

• Recourse Loans (where you’re personally responsible for the debt): If the lender forgives part of your balance, it’s likely considered taxable COD income.
• Non-recourse Loans (where the lender can only take the property but not pursue you for more money): The IRS usually treats the transfer of property as a sale, not as debt forgiveness, so you wouldn’t owe taxes on a deficiency balance. However, you might still owe capital gains tax if the property’s value exceeded your adjusted cost basis (what you originally paid plus improvements).

Insolvency or Bankruptcy Can Reduce Your Tax Bill

If your debts are greater than your total assets (meaning you’re insolvent), or if you filed for bankruptcy, you might not have to pay taxes on canceled debt. The IRS allows an exclusion for insolvent taxpayers, but you may have to file Form 982 to claim it.

State Taxes Can Be Different

Even if the IRS doesn’t tax you on forgiven debt, your state might. Some states follow federal tax rules, while others tax forgiven mortgage debt differently. Checking with a tax professional is crucial to avoid surprises.

You’ll Get a Tax Form from Your Lender

If your lender cancels $600 or more of your mortgage debt, they are required to send you Form 1099-C, reporting the canceled amount to the IRS. If you believe the debt should be excluded from your taxable income (such as under insolvency rules), you’ll need to file the proper forms to explain why.

The explanation above is just a general guide. For personalized advice on how your taxes will be affected if you pursue a deed in lieu of foreclosure, please speak with a tax professional. 

What Are the Advantages of Taking a Deed in Lieu of Foreclosure?

Helps You Avoid the Foreclosure Process

A foreclosure can drag on for months or even years, leaving borrowers stuck in financial uncertainty while still being responsible for the home. With a deed in lieu, you can walk away from the mortgage much faster, avoiding costly foreclosure proceedings, mounting legal fees, and the stress of having a foreclosure hanging over you.

Less Damage to Your Credit

Foreclosure can severely impact your credit score and stay on your credit report for up to seven years, making it harder to get loans, rent a home, or even pass certain job background checks. A deed in lieu isn’t great for your credit either, but it usually does less damage than a foreclosure. In some cases, lenders may report it in a way that allows for a quicker financial recovery.

You Might Be Released from the Remaining Debt

One of the biggest concerns borrowers have is whether they’ll still owe money after they hand over the property. With a foreclosure, the lender could still come after you for the unpaid balance if the home sells for less than what you owe. This means that a foreclosure doesn’t automatically relieve you of your financial obligations under the mortgage. With a deed in lieu, you have a better chance of negotiating with the lender to waive the deficiency of the debt.

Possible Cash Assistance for Moving

Like we stated earlier, some lenders offer “cash for keys” programs, where they pay you to help with moving costs in exchange for leaving the home in good condition. This can make the transition much easier, especially if you’re struggling financially and need money for a security deposit on a rental.

Less Public Scrutiny

Foreclosures are public record, which means anyone—including future landlords, employers, and lenders—can see it. A deed in lieu, on the other hand, is a private agreement between you and the lender. You avoid the embarrassment of a public auction, and it may not leave as big of a stain on your financial history.

You Can Move Forward Sooner

With a formal foreclosure, you could be battling legal proceedings, potential eviction, and financial uncertainty for a long time. A deed in lieu may allow you to close this chapter sooner, giving you a clean break so you can start rebuilding your finances. Some borrowers find they’re able to qualify for a new home loan much faster after a deed in lieu than after a foreclosure.

No Risk of Legal Action Down the Road

In some states, lenders can sue borrowers after a foreclosure sale if they don’t recover the full amount owed when selling the home. This is called a deficiency judgment, and it can haunt borrowers for years. A deed in lieu, especially if negotiated properly, can prevent this from happening by ensuring the lender waives their right to sue for the remaining balance.

A More Dignified Exit

Facing foreclosure can feel overwhelming and humiliating. Instead of being forced out by legal action, a deed in lieu allows you to walk away on your own terms, knowing that you handled the situation in the best way possible.

Cons of a Deed in Lieu 

While a deed in lieu can help you avoid foreclosure proceedings, it may still cause some problems for you:

You Lose Your Property and Any Equity You Built

Handing over your property to the lender means you give up any equity you might have had. If you’ve been paying your mortgage for years and built up value in the home, that equity is lost. Even if the market improves and the property’s value increases in the future, you won’t see any benefit because you no longer own it.

It Can Hurt Your Credit Score

A deed in lieu still damages your credit, though usually not as much as a foreclosure. It will stay on your credit report for several years, making it harder to qualify for a new mortgage or get good loan terms. If you were hoping to buy another home soon, this could set you back financially.

You Might Owe Taxes on the Forgiven Debt

If the lender forgives any remaining mortgage balance, the IRS could consider that taxable income. That means you might end up with an unexpected tax bill just for walking away from the loan. There are some exceptions, such as insolvency (when your debts exceed your assets), but you’d need to check with a tax professional to see if you qualify.

It Doesn’t Always Clear Your Debt

Many people assume that signing over the property means they’re completely free of the mortgage, but that’s not always the case. If the lender doesn’t agree to waive the deficiency balance, they could still come after you for any unpaid portion of the loan after selling the property. It’s critical to get written confirmation that your lender is forgiving the remaining debt, or you might face collection efforts later.

The Process Can Be Emotionally Difficult

Even though a deed in lieu might make sense financially, losing your home is still a tough experience. It can be stressful to move unexpectedly, deal with the paperwork, and figure out where to go next. The emotional toll is something to consider, especially if you’ve lived in the home for years.

Watch this video to learn more about the disadvantages of a deed in lieu of foreclosure:

Ways to Avoid Foreclosure Without Signing a Deed in Lieu of Foreclosure Agreement 

If you decide that a deed in lieu (and certainly foreclosure) is not for you, there are other options:

• Mortgage Loan Modification: This involves reworking the terms of your deed of trust with your lender to make your mortgage payments more affordable. This could help you stay in your home and avoid foreclosure. 
• Short Sale: In a short sale, you sell your home for less than the amount of the balance of your mortgage. This does require lender approval. Less effort is required in a deed in lieu vs a short sale where you have to find a new mortgage buyer yourself.
• Mortgage Forbearance: Mortgage forbearance is a temporary relief option where a lender allows a borrower to pause or reduce mortgage payments for a set period due to financial hardship. It does not forgive the missed payments but provides time for the borrower to recover financially. Once the forbearance period ends, the borrower must repay the deferred amount through a lump sum, increased monthly payments, or an extended loan term, depending on the agreement with the lender.
• Bankruptcy:  A last resort, in many cases, but it will relieve you of any and all debts you owe on your credit report, except for a few categories. However, foreclosure is included in bankruptcy.

It’s best to explore every option available to you if you want to avoid impacting your credit for a while. However, if you find yourself in deep water and your mortgage lender is willing to accept the deed in lieu, it may help you avoid greater financial hardship in the long run.

Pursuing a Foreclosure or a Deed in Lieu: What’s the Best Choice?

Deciding between foreclosure and a deed in lieu isn’t easy, and the right choice depends on your financial situation and long-term goals. If you want to stay in your home and believe your financial struggles are temporary, options like forbearance or loan modification might be worth exploring. But if keeping the home is no longer realistic, a deed in lieu could help you walk away with fewer long-term consequences.

One thing to keep in mind is that once an action for foreclosure is brought against you, your options start to shrink. At that point, avoiding serious damage to your credit becomes much harder, and the legal process can be stressful and costly. Acting early—before the lender starts pursuing foreclosure—gives you more control over the outcome.

FAQs

Can you buy a house after a deed in lieu of foreclosure?

Yes, but it won’t happen overnight. A deed in lieu of foreclosure could impact your credit and your ability to qualify for another mortgage because lenders see it as a sign of past financial trouble. How soon you can buy again depends on the type of loan you’re applying for. Conventional loans often require a four-year waiting period, while FHA and VA loans may approve you in as little as two years if you show financial improvement. The key is rebuilding your credit and proving to lenders that you’re financially stable enough to take on a new home loan.

How long does a deed in lieu of foreclosure take?

The process usually takes 30 to 90 days, but it depends on the lender and whether the property has liens on the property. If there are other unpaid debts attached to the home, such as a second mortgage or tax liens, the lender may take longer to review the case—or they could reject the deed in lieu altogether. Lenders prefer to take back properties that don’t have outstanding claims from other creditors. If your home has multiple liens, you may need to negotiate with those creditors first.

Who first signs a deed in lieu of foreclosure?

The borrower is typically the first to sign the deed because they’re the ones initiating the transfer.  Once the borrower signs, the lender reviews everything and, if they accept the transfer, finalizes the agreement. 

Is a deed in lieu considered a sale?

A deed in lieu means the borrower is giving up ownership to the lender rather than selling the home to someone else. However, for tax and legal purposes, some lenders and government agencies treat it like a sale, especially when calculating whether any forgiven debt should be taxed as income.