Going through a foreclosure is no picnic but you may be able to sidestep it by getting your lender to agree to a deed in lieu instead. While your credit score won’t escape completely unscathed, the damage may not be as bad which is good news if you’re planning to buy another home in the future. Taking a look at the pros and cons can help you gauge how a deed in lieu can affect your chances of becoming a homeowner a second time around.
Deed in Lieu Explained
When you request a deed in lieu, you’re acknowledging that you can no longer pay the mortgage and that you’re asking the lender to assume ownership of the home. If the bank agrees, then they can sell or auction the property and you walk away with nothing. Typically you have to be experiencing some sort of financial hardship to qualify and the home and surrounding property have to be in good condition.
Depending on the circumstances that lead to your request for a deed in lieu, the lender may or may not hold you responsible for any deficiency balance that’s still owed on the mortgage. If the bank forgives a portion of the loan, you’d have to count it as income on the next year’s tax filing.
How a Deed in Lieu or Foreclosure Impacts Your Credit
The main reason why you’d want to take a deed in lieu over a foreclosure is because it isn’t quite as devastating to your credit. According to FICO, a deed in lieu can knock 70 to 125 points off your score, depending on how good your credit was before you turned over the home. A foreclosure, on the other hand, can lower your score by as much as 160 points which is a much bigger deficit to try and recover from.
Your credit score is one of the most important things lenders look at when you’re applying for a mortgage so a deed in lieu wouldn’t be viewed as negatively as a foreclosure. The only time that it could end up being just as bad is if you owe the lender a shortfall on the loan and you can’t pay. In that scenario, they could sue you and if they win, the judgment would show up on your credit report.
If you’ve got an eligible loan, the Home Affordable Foreclosure Alternatives program can help you minimize the damage to your credit. If you qualify for a deed in lieu through the program, you won’t owe anything else towards the mortgage and you can even get up to $10,000 to put towards finding a new place to live.
Beware the Waiting Period
One thing that you need to keep in mind if you’re considering a deed in lieu is that you’re not going to be able to buy another home right away. Unless you’re planning to pay cash, you’re going to have to wait before you can apply for a loan. The length of the waiting period depends on the type of loan you’re going for.
In the case of a conventional loan backed by Freddie Mac or Fannie Mae, the waiting period for buying a home after a deed in lieu is four years. It stretches to seven if you lost your home to foreclosure. You can get the wait shortened to two and three years respectively but only if you can show that there were extenuating circumstances that caused you to fall behind on the mortgage.
With an FHA loan or a USDA loan, the waiting period is slightly shorter at three years. VA loans have the shortest wait time, at just two years. The waiting period is mandatory but you can use the time to your advantage by working on paying down your other debts and reestablishing a positive payment history.
When Your Lender Won’t Agree
If you’ve pleaded your case to the bank and they won’t budge on a deed in lieu, you have some fairly limited options at this point. One, you can allow the house to go into foreclosure. Your credit score is guaranteed to suffer and you could be liable for any money that the bank isn’t able to recoup on the loan once the house is auctioned off.
The other option is to file bankruptcy. A Chapter 7 proceeding would erase your obligation to pay anything else towards the mortgage but it wouldn’t block the lender from foreclosing. That may or may not be a concern if you were looking at losing the house anyway.
As far as how bankruptcy affects your credit, a Chapter 7 case can linger on your report for up to 10 years. Interestingly, however, it may be possible to get approved for a new mortgage in as little as two to three years after your case is discharged so that’s something to keep in mind if your lender refuses to see eye to eye on a deed in lieu.
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