Can You Ask for a Deed in Lieu With HELOC?

Deed-in-Lieu of Foreclosure

According to the legal website Nolo, in a deed-in-lieu of foreclosure, the borrower gives the home back to the lender in exchange for canceling the loan and any foreclosure proceedings. The lender must agree to forgive or release any mortgage deficiency that remains after selling the house. Additionally, the borrower typically has to put the house on the market for a period of time before approving the deed-in-lieu, or DIL.

DIL and the Second Lien

Securing a DIL is extremely difficult if there is a second lien on the property, such as HELOC or home equity loan. Because the HELOC is subordinate to the primary mortgage, it must agree to accept a settlement. The primary lender can offer the settlement if the home sells or the borrower may offer to settle for a portion of the loan balance. Both events are rare, but the second lienholder may insist that the homeowner attempt to sell the home prior to agreeing to a DIL.

Tax Liability

In a DIL, the total amount of equity forgiven by the lenders is sometimes converted to income under IRS guidelines. The Mortgage Forgiveness Debt Relief Act of 2007 forgives the income under certain circumstances; speak with a tax advisor to determine your eligibility. You may also declare insolvency or file bankruptcy to avoid the tax liability.

Filing bankruptcy has a profound and long-reaching effect on credit. Although it is possible to recover, it takes years. New loans, good insurance rates and possibly employment will be difficult to secure for some time, possibly several years.

What to Do if You Can't Qualify for a DIL

You may need to consider agreeing to a short sale if the lenders can't agree on a DIL. When it costs more to sell a home than it's worth, the home is "underwater" and may sell short. The lender agrees to accept less than the mortgage's principal balance, and it also pays the realtor and attorney fees. Just like the DIL, secure a lien release from the lender; otherwise, you may be liable for the difference between the proceeds and the balance owed.