The important title difference between a Washington deed-in-lieu of foreclosure and an actual foreclosure

A deed-in-lieu of foreclosure is a voluntary transfer of title by the distressed homeowner to the lender / mortgagee.  The deed-in-lieu can be a useful foreclosure alternative for both parties.  It can save the lender time and expense.  And for the borrower, the credit rating impact is less severe than a foreclosure and the deed-in-lieu can also eliminate the borrower’s exposure to a deficiency judgment.  However, a deed-in-lieu can have significantly different title consequences that must be considered by both parties before utilizing the foreclosure alternative. 

A deed-in-lieu is simply a conveyance of the borrower’s present interest to the lender / mortgagee.  There are no unique Washington rules or statutes governing the transaction. As is the norm with Washington deeds, the lender / grantee acquires no greater title interest than is presently held by the borrower / grantor.  Whereas a foreclosure, as explained in prior posts, conveys to the winning bidder at auction the title interest that was originally encumbered by the borrower.  Depending on the facts and circumstances, the title differences in what is acquired by deed-in-lieu versus foreclosure auction can be significant.  

Consider, for example, a case where the mortgaged interest given by the borrower is free and clear.  But then the borrower subsequently gives a 2^nd lien to a cash-out equity lender, and then sells an easement to his neighbor, and then gives up rights to an owner’s association.  The free and clear mortgaged interest is probably the more attractive interest than the present interest, which is encumbered with new liens and limitations.  In this case, a deed-in-lieu to the lender will result in a transfer of the weaker interest.  Whereas a foreclosure will result in the transfer of the stronger, free and clear interest to the winning bidder at auction.  It would make little sense for the lender to accept a deed-in-lieu under these circumstances.

This is not to say only lenders should be apprehensive about utilizing a deed-in-lieu.  The deed-in-lieu can be used to the advantage of the lender and disadvantage of the borrower.  I recall a situation where an unsophisticated borrower in financial distress gave a deed-in-lieu to his lender where the property had significant equity.  Had the borrower done nothing, forcing the lender to foreclose, there would have been a sale surplus following foreclosure which the borrower could claim.  In other words, the borrower’s equity would be preserved through the Washington statutory foreclosure process.

In sum, the deed-in-lieu can be a useful foreclosure alternative, but both sides – lender and borrower – should closely evaluate the title consequences.  And for the lender, as is a theme throughout this blog, always get title insurance for the transaction.