Deed in Lieu of Foreclosure vs. Short Sale

January 30, 2013 12 Comments »
Deed in Lieu of Foreclosure vs. Short Sale

It’s time for another mortgage match-up, with the latest in the series pitting the lesser known deed in lieu of foreclosure vs. the popular short sale.

Nowadays, there are plenty of options to get rid of your home and avoid foreclosure, even if you owe more than the property is currently worth.

By avoiding a full-blown foreclosure, you can reduce the negative impact to your credit score and ensure the lender won’t come after you for any deficiency balance.

Additionally, you may be able to qualify for a mortgage much sooner if you go with one of these foreclosure alternatives.

What Is a Deed in Lieu of Foreclosure?

In short, a deed in lieu of foreclosure is exactly what it sounds like. Instead of foreclosure, you agree to voluntarily deed your property to the lender.

In exchange for this transfer of ownership, the lender will release the associated lien (mortgage), allowing you to move on with your life.

However, banks will only agree to a deed in lieu if you keep the property in good shape and meet some sort of hardship requirements.

The tradeoff is that the bank gets a property free from damages typically associated with foreclosure, and they don’t need to deal with costly foreclosure proceedings.

Of course, with home prices much lower now than they once were, properties are often being dumped for less than what is owed on the mortgage.

As a result, the lender may be able to come after you for the deficiency balance, or the shortfall between the current property value and the loan balance.

If this is the case, you may be on the hook for all or part of the shortfall, which clearly isn’t ideal if you can’t even afford your mortgage payments.

This is why it’s imperative that you negotiate with the lender to forgive any deficiency balance before agreeing to the deed in lieu.

You must also do this with any junior liens, or second mortgages (or thirds). If you don’t, they too can come after you for any shortfall in certain situations.

Why Choose a Deed in Lieu?

Aside from avoiding an outright foreclosure, a deed in lieu may be the quickest option.

Instead of being tasked with selling your home and waiting for the bank to accept the short sale offer, you can have the bank take care of it.

However, the bank may still ask that you list the property for a period of time before agreeing to a deed in lieu.

Also, a deed in lieu isn’t nearly as bad as a foreclosure with regard to your credit score. It will still hurt your credit, but the impact will be less, assuming there is no deficiency balance.

Check out the credit score impact of a deed in lieu as opposed to a foreclosure, according to FICO:

deed in lieu impact

It’s still not great, but it won’t do as much damage as a foreclosure.

On top of that, you’ll be able to qualify for a new home loan in a shorter period of time.

Instead of waiting up to seven years after a foreclosure, you may only need to wait as few as two years if you have extenuating circumstances.

Lastly, you may be able to stay in your home with a deed in lieu if the lender offers a “Deed-for-Lease” option, as Fannie Mae and Freddie Mac now do (along with Bank of America). Or you may receive some spending money for relocation costs.

What About a Short Sale?

I’ve already written extensively about short sales, which are probably the most popular foreclosure alternative available today.

Put simply, you must convince the lender to allow you to sell your property for less than the associated mortgage balance.

The downside is that you must list your home for sale, which obviously takes work, results in people tracking mud through your home, dealing with annoying real estate agents, and can take many (many) months to finalize.

First off, you need the bank to approve the sale, and secondly, you need to close the deal. It’s a lot more difficult to sell homes these days, so it can be quite a pain.

However, new rules have sped up short sales, and now that they’re so commonplace, the process can be a lot more effortless.

The result is similar to a deed in lieu in that you are released from the loan once the home is sold, and you avoid foreclosure.

Again, you must ensure that there isn’t a deficiency balance to avoid owing any money after the deal is done.

And if there are second or third liens, they must also be dealt with.

Tip: If you complete a short sale or deed in lieu via the Home Affordable Foreclosure Alternatives (HAFA) program, the deficiency balance must be waived.

The advantages of a short sale are like a deed in lieu in that you can reduce the credit score impact and get a new mortgage sooner. You may also be offered a financial incentive to short sell.

The drawback is that a short sale may be more time consuming and tedious. However, banks are probably more willing to approve a short sale than they are a deed in lieu, especially if there is another mortgage involved.

Though beginning in March, Fannie and Freddie will allow borrowers with illness or the need to relocate for a job apply for a deed in lieu, even if current on their mortgages. This just so happens to be taking place when home prices are on the rise…

In either a short sale or deed in lieu, there are also potential tax consequences, so consult a CPA and/or a lawyer before deciding which choice is best for you, if either.

Read more: Foreclosure vs. short sale


  1. Neal Trice February 24, 2013 at 6:01 pm -

    The comment on the real estate agent shows that you have little knowledge of the real world we are in. Hope you can sell your property by yourself .

  2. gene currin October 15, 2013 at 12:11 am -

    I live in Florida and am buying a house under ashort sale , i have a contract . We also live in the house and pay the borrower rent. we are waiting for the short sale approval.
    I was told yesterday that the borrower want to do a deed in lieu of foreclosure. Is this illegal ? We want the house.

  3. Colin Robertson October 15, 2013 at 11:37 am -

    As you noted, the short sale still requires bank approval, despite being in contract between buyer and seller. Ask your real estate broker/agent how to proceed.

  4. Michael February 21, 2014 at 5:00 am -

    I always wondered what the benefit of a deed in lieu was instead of foreclosure/walking away. Makes sense to avoid some of the repercussions of foreclosure.

  5. Andrew February 28, 2014 at 1:45 am -

    So there is some credit benefit to the deed in lieu…I also like the idea of your lender not coming after you.

  6. Laura F. April 25, 2014 at 8:42 am -

    can I refinance after deed in lieu

  7. Colin Robertson April 25, 2014 at 8:55 am -

    It’s the same as the waiting period after a short sale. Basically 2 years if you put at least 20% down, 4 years if between 10-20%, and seven years if less than 10% down. Those are Fannie’s guidelines, it could be less with FHA or longer with Freddie.

  8. Scott February 20, 2015 at 7:28 pm -

    Is a deed in lieu better than a foreclosure for the mortgage company as well? Meaning, does the mortgage company stand to make more off the property with a deed in lieu vs a foreclosure sale? Can a deed in lieu be done last minute before a sale date or is there a cut off if there is a sale date?

  9. Colin Robertson February 21, 2015 at 4:41 pm -


    As I noted in the article, the benefit to the bank is that the property should be well taken care of, as opposed to abandoned and left damaged, and they may save on foreclosure costs.

  10. Mike February 25, 2015 at 11:29 am -

    What about after filing bankruptcy?
    We filed 4 years ago when I got cancer, but managed to still keep up the house payments until about 4 months ago.
    We decided to let the house go into foreclosure. I understand the foreclosure process can take a long time, which would give us a chance to try to save some of that mortgage payment. Does “deed in Lieu of foreclosure” mean that you might not be able to stay in the house as long as if you waited for foreclosure?
    We will probably not purchase another home as I am 67 and have very little savings.. At this point we are hoping to buy a old mobile for cash.

  11. Rob March 18, 2016 at 6:30 pm -

    I have 2 rental homes and own my home . #1 rental i have an interest only loan that will convert to a 20 year term on the balance of $ 156,000 also have a second mortgage interest only loan that i pay $91.00 at 9.675%. My payments will go up substantially plus the home needs a lot of work, new roof, siding replaced, old stucko in front and original a/c unit. Home is 23 years old. The home is valued at approx. $135,000 I would like to get out of this rental. Can i do a deed-in-lieu or short sell. i do have equity in my home and some savings but looking ahead to retirement within the next 10-12 years. Thanks Rob

  12. Colin Robertson March 22, 2016 at 11:50 am -


    If you have equity you may want to try a traditional sale first to avoid any credit-related hit.

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