Another alternative to foreclosure is a deed in lieu in foreclosure. This is a procedure whereby the borrower/property owner gives a grant deed to his or her property to the lender, and the lender does not foreclose. Like other alternatives to foreclosures, deeds in lieu have advantages and disadvantages.
The advantages of deeds of lieu are simple. To the borrower, they are a fast and clean way to get out of a bad situation, and they may hurt the borrower’s credit less than an outright foreclosure. To the lender, a deed of lieu is faster and less expensive than a foreclosure, and, since deeds in lieu are based upon agreement rather than coercion, may make it possible to get the property back in better condition.
To the borrower, a deed in lieu has one huge disadvantage; it may not wipe out the mortgage. As with short sales, it is vitally important to the borrower to get an agreement from the lender that, after the deed is given, the mortgage debt is forgiven. Otherwise, the borrower may surrender his or her property, only to be told that the debt is still owing.
To the lender, a deed in lieu is troubling because it may not result in clean title. When a secured lender forecloses on property, the foreclose wipes out all interests junior to the lender, such as junior liens. When a lender takes a deed in lieu, however, the lender steps into the shoes of the borrower; if there were junior liens against the property, they probably remain against the property. Thus, it is foolish for a lender to take a deed in lieu unless it obtains title insurance, assuring it that it is taking the property free and clear of liens. Many lenders will not take deeds in lieu, unless the borrow has no other assets and no ability to pay the debt.
Under Civil Code Section 2889, deeds in lieu of foreclosure which are given at the same time that the loan documents are drafted are void. Deeds in lieu must be given at a later time, and some valuable consideration must go to the borrower. (The usual consideration to the borrower is cancellation of the debt, but other sorts of consideration are possible, which is why the debt may still be owing after the deed is given.)
Deeds in lieu are not valid unless both sides agree to them. Obviously, the borrower/property owner must agree; he or she must sign the grant deed. Sometimes a borrow/property owner will try to force the borrower to accept a deed in lieu, by the simple tactic of drafting up a grant deed to the borrower and recording it. As a legal matter, title does not pass to the lender unless the lender accepts it. If the lender discovers that the borrower has recorded a deed in its favor, which the lender does not accept, the lender should immediately record a Notice of Nonacceptance which conforms to the requirements of Civil Code Section 1058.5.