A deed in lieu of foreclosure is a voluntary agreement: the borrower signs the property over to the note holder, and the note holder agrees not to foreclose. “In lieu” means “in place of”, so the deed takes the place of the foreclosure sale. It happens only if both sides consent.
How one is carried out
A borrower who has stopped paying and cannot catch up offers to hand back the property instead of waiting to be foreclosed on. If you, as note holder, are willing, the steps generally run in this order:
- You and the borrower agree the terms in writing, including what happens to the remaining debt.
- You order a title search to see what else is recorded against the property.
- The borrower signs a deed transferring the property to you, often with a statement that the transfer is voluntary.
- The deed is recorded in the county records.
- You release or cancel the note as the agreement provides.
- The borrower moves out by the agreed date.
Liens that stay with the property
A lien is a legal claim against a property, and liens rank in order of who is paid first. Foreclosure generally clears the liens that rank below yours, whereas a deed in lieu generally leaves them in place, because you are taking the property as it stands.
Suppose the borrower has a second mortgage, a court judgment, unpaid contractor bills or tax debts recorded against the property. Those can still be attached after the deed is signed, and you would own a house carrying someone else’s claims. The title search therefore has to come before the signature. If it turns up junior liens, either they are settled as part of the agreement or foreclosure becomes the cleaner route.
What a note holder gains by accepting
A signed deed can take less time than a contested foreclosure, and there are fewer legal steps to pay for. The outcome is known once the deed is recorded, where a foreclosure sale can end in more than one way. The move-out date and the condition the property is to be left in can also be written into the agreement, which a foreclosure does not give you.
The borrower has reasons of their own. A deed in lieu is private compared with a public sale, and the agreement may release them from whatever debt remains.
Points to settle before you sign
- The remaining debt. The agreement should say plainly whether the debt is fully satisfied or whether a shortfall is still owed. State law affects what is allowed.
- Voluntariness. The borrower’s consent has to be real and documented, since an agreement that looks forced can be challenged later.
- Bankruptcy. If the borrower files bankruptcy soon afterwards, the transfer may be examined.
- Carrying costs. Once you own the property, the taxes, insurance and maintenance are yours.
- Tax treatment. Taking back a property can have tax consequences for both sides, so speak to a CPA before signing.
Rules on all of these differ by state. Have the deed and the agreement drafted or reviewed by an attorney in the state where the property is located, since this page is background and not legal advice.
How it compares with the other routes
| Route | What you end up with | Main drawback |
|---|---|---|
| Deed in lieu | The property, by agreement | Junior liens generally stay attached |
| Foreclosure | Sale proceeds or the property | Legal cost and time, set by state process |
| Loan workout | A note that is paying again | Depends on the borrower keeping to new terms |
| Selling the note | Cash, and no further involvement | A non-performing note sells at a deeper discount |
A loan workout, in the third row, means changing the terms so that the borrower can start paying again. That and the other terms in the table are defined in the note basics hub, and the second row is set against land contract remedies in foreclosure vs forfeiture.
As for the last row, the gap between what is owed and what a buyer pays is wider on a note in default, because the buyer takes over the work of resolving it. To put a real figure in that row, find out what the note would sell for in its current state before you discuss a deed with the borrower, and weigh it against the legal bills in whether selling a note is cheaper than foreclosing.
If you do not want the property back
A deed in lieu turns you into a property owner, with a house to insure, maintain and eventually sell. That is a poor fit for a holder who lives in another state or who simply wants to be finished with the loan.
The decision comes down to two figures: what the note would sell for as it stands, and what the property is worth less the cost of taking it back, carrying it and reselling it. Work out the second one, counting what the title search found and a year of taxes and insurance, before the borrower hears that a deed is on the table.
Related questions
Does a note holder have to accept a deed in lieu?
No. It is a voluntary agreement on both sides. A note holder can decline and foreclose, agree new payment terms, or sell the note.
Does a deed in lieu remove other liens on the property?
Generally not. Foreclosure generally clears liens that rank below yours, but a deed in lieu transfers the property with those claims still on it. Order a title search before you agree.
Can I sell my note instead of taking the property back?
Selling is open to you where a buyer of defaulted notes is willing to take yours on. The price is lower than for a note that is paying, but you avoid owning and managing the property.