Deed in Lieu of Foreclosure in a Divorce

by Anna Assad

Divorcing your spouse can wreak havoc on your personal finances, especially if you own a home with a mortgage on it. You may ask your lender for a deed in lieu of foreclosure if you can't sell or afford the payments. You'll use the deed in lieu to give the home back to the lender before they drag you through the formal foreclosure process in your state, or before they finish it.

Deed in Lieu of Foreclosure

You and your spouse return the home to the lender on the deed in lieu of foreclosure, making the lender the new owner. In return, the lender doesn't take you through foreclosure and releases you from some or all liability for the mortgage debt.

Eligibility

Eligibility for a deed in lieu of foreclosure varies by lender. You may have to prove you're unable to pay your current mortgage by giving the lender documentation of your financial hardship. Financial hardships include divorce, so you may need to provide copies of papers from your divorce case to prove it. Your lender may not let you apply until you're behind on your payments or you've tried to sell your home for a specific period, such as 90 days.

The Agreement

Your lender will create a deed-in-lieu-of-foreclosure agreement that lists the terms of the deal. You and your spouse may ask the lender to include some favorable terms. For example, you can ask for a clause preventing the lender from reporting the deed as a foreclosure on your credit reports. You and your spouse must work with the lender to gain final approval for the deed in lieu. You won't get a deed in lieu if either of you fails to fulfill the lender's requirements.

Tax Consequences

Both you and your spouse may face tax consequences for the forgiven debt. The lender reports the debt as forgiven to the IRS, which treats it as taxable income. You'll each have to include your half of the forgiven debt on your tax return. You may avoid additional taxes if you qualify for any exemptions regarding forgiven mortgage debt under federal laws at filing time.

Deficiency Judgment

Your lender might have the right to sue you and your former spouse in civil court after they sell the home under state laws. If the lender sells the home for less than what you owed on the mortgage plus the fees and costs the lender is allowed to recoup, they can get a deficiency judgment against you for the difference. You and your spouse may ask the lender to include in your deed-in-lieu agreement a clause that prevents them from getting a deficiency judgment.

Considerations

Your lender doesn't have to agree to a deed in lieu and you need your spouse to go along with it, even though you're divorcing. You may ask the judge for assistance if he refuses to go along with the deed in lieu, but whether the judge can or will help depends on your personal circumstances. Your home is part of the property settlement aspect of your divorce, so you need to come to an agreement over the home with your spouse. If you're the only person on the deed and mortgage, you can do a deed in lieu alone, but your lender may want your spouse to sign a consent form.