A deed in lieu of foreclosure is a deed given by the owner of mortgaged property to the holder of the mortgage or its designee where the mortgage is in default and foreclosure is a possibility. A deed is given and accepted as an alternative to ("in lieu of") foreclosure. Unlike a foreclosure, a deed in lieu of foreclosure does not extinguish any of the liens and encumbrances affecting the property.
Most courts recognize the execution of a deed in lieu of foreclosure in a transaction subsequent to the original mortgage transaction as a legitimate alternative to foreclosure proceedings. However, deeds in lieu of foreclosure can be subject to judicial attack by their grantors and their grantors' creditors.
Grounds for attacks on deeds in lieu of foreclosure include the following:
• That the deed was an equitable mortgage - that the parties intended the deed to be given as security for a debt and that the deed was not an absolute conveyance.
• That the deed is either a preferential or fraudulent transaction within the purview of the provisions of the federal Bankruptcy Act or any other related state law.
• That the deed is a device to clog a mortgagor's right of redemption.
• Unfairness of the consideration.
• Coercion, fraud, oppression, duress, and undue influence.
• That the deed is not subsequent to the execution of the mortgage but contemporaneous with it.
• That the grantor/mortgagor was insolvent at the time of the execution of the deed.
An estoppel affidavit (executed and acknowledged by the grantor/mortgagor, attesting to the fairness of the transaction, the consideration exchanged, the value of the property, and other factors showing an intention to make a genuine transfer) or a recital (inserted directly in the deed) are supporting documents used to forestall challenges to these transactions.
State law and local title standards must be consulted in regard to the consideration and treatment of deeds in lieu of foreclosure.
Deeds In lieu Of Foreclosure Requirements
The following is a list of items to be considered in connection with a request to insure a deed in lieu of foreclosure.
1. The deed in lieu must not be given as additional security for a debt.
2. The grantor/mortgagor must not be subject to duress or undue influence.
3. We must receive a copy of all agreements between the parties relating to the deed in lieu of foreclosure. Neither the agreement between the parties nor the deed in lieu instrument should contain any right, option or obligation of the grantor/mortgagor to redeem, reacquire or repurchase the property, or a right by any party to rescind the transaction. If any agreement or instrument includes any such rights or obligations, whether or not it is recorded in the Public Records, consult our underwriting personnel.
4. The deed in lieu must be properly executed and acknowledged. It must be absolute, unconditional and unqualified. Recitals in the deed in lieu describing the nature of the transaction are permitted and encouraged. However, if the deed in lieu contains any conditional language, consult our underwriting personnel.
5. The transaction must close. If the deed in lieu transaction involves an extended escrow or unresolved conditions, consult our underwriting personnel.
6. The grantor/mortgagor and all guarantors, if any, must be released from personal liability on the underlying debt. A customary satisfaction/release, in recordable form, is evidence of such release.
7. The mortgage must be released of record. If not, the mortgage must remain as an exception on the policy.
8. The grantor/mortgagor must vacate the property and surrender possession to the grantee/mortgagee.
9. All pending foreclosure proceedings, if any, must be dismissed.
10. The grantor/mortgagor must execute a Deed in Lieu of Foreclosure Affidavit and Estoppel Certificate, which may be modified consistent with local practices, in addition to a customary seller's/owner's affidavit. Where possible, and if consistent with local practices, record the Deed in Lieu of Foreclosure Affidavit and Estoppel Certificate. Otherwise, if possible, and if consistent with local practices, require similar recitals to be inserted into the deed in lieu.
11. Search, examination and underwriting must comply with customary standards for owner's policies. This is particularly important since a deed in lieu is often given by a financially distressed borrower, and other liens and judgments may encumber the property.
Owner's Policy To Be Issued In Favor Of A Grantee In A Deed In Lieu Of Foreclosure
Nature of Title Acquired
The grantee's/mortgagee's title, as the new owner of the property, is acquired subject to all the matters affecting the title to the property, including mortgages and other interests in the land.
Amount of the Owner's Policy
The amount of the owner's policy should equal the amount of the outstanding principal indebtedness due, plus interest, taxes, and expenses, or the current fair market value of the property. This amount cannot be increased until the title has been conveyed to a third party purchaser.
Endorsement of an Existing Mortgage Policy
It is not permissible to endorse an existing loan policy in order to reflect a transfer of the property in favor of the grantee/mortgagee.
Extended Coverage and Mechanic's Lien Coverage
It is not permissible to offer any extended coverage (deletion of the general or printed standard exceptions, including mechanics' lien coverage and rights of parties in possession) or provide endorsements solely on the basis that such coverage was given in the prior loan policy. For existing 1 - 4 family residential dwellings, issuing offices may underwrite the removal of standard exceptions and the provision of endorsements (if requested) consistent with customary practices for owner's policies. This may involve a current affidavit from the current owner relating to absence of lienable work at the premises and the absence of any parties in possession, unless such representation is otherwise contained in the Deed in Lieu of Foreclosure Affidavit and Estoppel Certificate. For commercial properties or deeds in lieu involving construction loans (residential or commercial), please consult our underwriting personnel. In such situations, factors to be considered include the nature and value of work performed during the applicable mechanic lien filing period, among others. In all situations, be mindful of the fact that a deed in lieu is often given by a financially distressed borrower, and that indemnities, including gap indemnities, may be of limited practical value.
Existing Liens and Encumbrances
A deed in lieu of foreclosure does not extinguish any liens or encumbrances affecting the property. It is not permissible to omit any lien or encumbrance on the basis of either their inferiority to the mortgage or their possible elimination by a foreclosure action. All recorded liens and encumbrances (including, for example, junior mortgages and judgment liens) must be released of record or excepted. All unrecorded liens (including, for example, taxes and homeowner's/condominium association dues) must be paid in full or excepted. Since the deed in lieu transaction may not involve any exchange of cash consideration, ascertain that sufficient funds have been received to satisfy a lien before omitting it.
Omission of the Mortgage
In some jurisdictions, absent specific language disclaiming merger, a deed to a mortgagee may be treated as extinguishing the lien of the mortgage. Nevertheless, you should continue to show the mortgage as an exception, unless it is formally released of record, or you receive underwriter approval.
If you are unable to continue (bring down) the title to the closing date, consider retaining a gap exception until the deed in lieu is recorded.
Issuing a policy to the grantee of a deed in lieu of foreclosure or a lender to such grantee is an extrahazardous risk requiring underwriter approval.
Not Releasing The Mortgage In A Deed In Lieu Of Foreclosure
In most cases, as part of the transaction, the mortgage will be released by the grantee/mortgagee. If the mortgage is not released, it is possible that the courts may treat the deed in lieu merely as a deed given as additional security for a debt.
In certain situations, sometimes involving commercial property, a grantee/mortgagee may wish to preserve the mortgage in an effort to maintain its priority position against subsequently filed liens or encumbrances. In such situations, it is permissible to accommodate such request upon compliance with the following additional requirements:
• The deed in lieu must contain an appropriate recital stating that there is no intention to merge the interest of the mortgagee under the mortgage, and that such interests shall remain separate.
• The agreement between the parties must unconditionally and irrevocably release the grantor/mortgagor and all guarantors from personal liability under the note. This should be distinguished from a covenant not to sue and/or a partial release or conditional release of liability. If the transaction does not unconditionally and irrevocably release the grantor/mortgagor and all guarantors from all personal liability, contact our underwriting personnel.
Note: The above requirements are in addition to any other requirements that need to be made in connection with deeds-in-lieu of foreclosure transactions.
If the mortgage has not been released, and if you are asked to insure a subsequent foreclosure of the unreleased mortgage following a deed in lieu transaction, contact our underwriting personnel.
A Deed In Lieu Of Foreclosure in the Recent Chain of Title
If your search discloses a deed in lieu of foreclosure recorded in the chain of title within 90 days prior to the current transaction, contact our underwriting personnel. In such situations, additional requirements and exceptions may be raised. For example, it may be necessary to confirm that the grantor/mortgagor of the deed in lieu has not filed bankruptcy. In addition, you may be required to obtain verification of the outstanding balance of the recently released debt in order to compare it to the current sale price. Otherwise, it may be necessary to insert a creditor's rights exception into the new policy.