What is a Deed in Lieu of Foreclosure?
A Deed in Lieu of Foreclosure (“DIL”) is a deed instrument where the borrower in a loan transaction conveys its interest in the subject real property to the lender to satisfy its loan obligations and avoid foreclosure on the property. The DIL is typically used when a borrower defaults on a loan and is unable or unwilling to resolve those defaults, but both parties agree they do not want to proceed with the lengthy and expensive foreclosure process.
Why use a Deed in Lieu instead of Proceeding with Foreclosure?
A DIL provides multiple advantages to both the lender and borrower. The main advantage for both sides is reduced cost and time. A DIL replaces the foreclosure process, allowing the parties to quickly resolve the issues at hand. Not only does this allow for efficiency, but it also shortens the lender’s time between default and recovery of its investment in the deal. A DIL also benefits borrowers by reducing the negative consequences of a foreclosure, particularly the long-term damage of having a foreclosure on their credit report. In addition, borrowers are typically discharged from all obligations related to the loan through a DIL, allowing the borrower to avoid a deficiency judgment that they would typically be responsible for post-foreclosure.
A DIL is also advantageous for maintaining an amicable relationship with the other parties involved. An amicable relationship may help reduce the risk of a borrower damaging or neglecting the property throughout the process. Lenders should aim to ensure the property remains in good repair to preserve the property’s value and avoid costly repairs before the lender can operate or sell the property.
Additional Considerations for Lenders Utilizing a Deed in Lieu
Like anything else in real estate finance, there are additional items lenders should consider before proceeding with a DIL. First, lenders should always ensure that their agreement with the borrower is fully documented in writing. This will memorialize the agreement, providing clarity should issues arise during the DIL process. Lenders should be careful to ensure the written agreement provides for sufficient consideration to protect against claims of duress by the borrower.
Next, a lender should consider its own situation and determine its goals. Initially, consider what will happen to the property once the DIL process is complete – is the lender able to hold and operate the property to generate income, or would the lender need to sell the property? This will highly depend on the lender’s experience, abilities, and goals. Some lenders are willing to manage property, but others may not be interested in maintaining a larger real estate portfolio. Additionally, if the lender is an entity, it should consider whether the entity has the power to own, hold, and operate real property. Some entities are limited in purpose and power and may not have such authority.
The desirability of a DIL is also impacted by additional liens that may exist on the property. Unlike a foreclosure, a DIL does not wipe out junior liens on the property, instead leaving the lender to take ownership of the property subject to any existing liens. Before entering into a DIL, a lender should first obtain a current title report on the property to determine whether there are subordinate liens that might make a foreclosure necessary. The title company will complete a current title search and can also assist with preparing the closing statement and other necessary documents. As part of closing a DIL, a lender should protect itself by obtaining a new owner’s title insurance policy.
Lenders should further consider the market value of the property at issue, taking into account both the local market and condition of the property. Real property where the value meets or exceeds what is owed to the lender is ideal for the DIL process, as the lender can then likely resell the property to recoup the loan funds. However, for properties where the value is substantially less than what is owed, a DIL may not be the best option. This is because the DIL process does not typically leave the lender an ability to obtain a deficiency judgment, so the lender is unlikely to recover any deficient balance once the DIL is complete.
How does a Deed in Lieu work?
- Initial steps for Lender to take:
- Confirm that the proposed terms of the offer from the borrower are in writing. If the proposed offer is not in writing, require a written offer from the borrower.
- Confirm the following:
- Nature and extent of all existing borrower defaults;
- Accrued and unpaid interest, default interest, and late fees, if any;
- Prepayment fees applicable to the transaction; and,
- The outstanding amount of the debt under the loan.
- Review the loan documents to make sure you have a complete loan file, that the loan documents are enforceable, and that there are no deficiencies in the loan documentation that require amendments before closing.
- Obtain and review a current title search to determine status of title and whether there are any tax liens or judgments.
- Inspect the property and applicable public records.
- Order and review an independent appraisal.
- Closing the DIL:
- Order the transaction documents from lender’s counsel.
- Coordinate closing/recording of the DIL and issuance of the new owner’s title policy through the title company.
Your counsel can assist with keeping these items on track and moving towards a smooth resolution.
Common Documents that are used with DILs
- Grant deed
- Transfer agreement
- Bill of sale
- Estoppel affidavit
- Release of claims
- A non-foreign status certificate
- Covenant not to sue
- Escrow agreement
- Assignment of leases, rents and security deposits
- Assignment of contracts, warranties, permits, and licenses
- Tenant estoppel certificate
- SNDA, if required by the lender
- Tenant notice letter advising the tenants of the change in ownership
If you need help preparing a Deed in Lieu of Foreclosure or have questions about whether you should be obtaining a Deed in Lieu of Foreclosure for your loan, contact Geraci Law Firm for a consultation today.