A method of dealing with distressed properties little known since the Great Depression is becoming more widespread again in the drawn-out U.S. housing crisis.
In a "deed in lieu of foreclosure," routinely called just deed in lieu, a homeowner who can no longer make payments on a house worth less than what is owned on it turns the deed over to the mortgage holder. Avoiding foreclosure benefits both the homeowner and the bank or other lender.
"Unfortunately, everybody knows about foreclosure. People knew about deed in lieu in the 1920s and '30s, and then it kind of fell out of awareness," said James E. Schroeder, who handles a lot of distressed-property transactions these days as a real estate attorney in Egg Harbor City and a licensed real estate agent with Keller Williams in Northfield.
Banks like deed in lieu conveyances because foreclosures - especially in a state such as New Jersey where they're a court procedure - take 18 to 24 months and cost $10,000 or more, he said. "And a lot of crazy things can happen in a foreclosure."
Deed in lieu allows homeowners to transition to a more affordable living situation without a substantial deficiency judgment hanging over them for years, or a personal bankruptcy.
In a foreclosure, the lender can seek to recoup the difference between what was owed on the mortgage and what it recovered through a foreclosure or sheriff's sale, said Schroeder, 40, of Hammonton. "The bank could choose to pursue the family for the next 30 years to attempt to garnish wages, remove funds from bank accounts, inheritances, gambling winnings, almost anything. To avoid this, people will almost always declare bankruptcy at some point."
Lenders also agree not to pursue a deficiency judgment in a short sale, which remains the preferred method for selling an underwater property and is the most popular of the three main options.
"My wild guess is that of distressed properties now, 20 percent are going to foreclosure, 20 percent to deed in lieu, and the remaining 60 percent are short sold," Schroeder said.
In a short sale, the homeowner finds a buyer for the house, and the lender agrees to accept less than what is owed on the mortgage.
Daniel J. Young, an attorney practicing in Ocean City, said short sales have been much more common in the second-home market there.
"If the numbers are all the same, the banks would rather have a short sale. Then the whole thing is packaged, paid off, and the bank gets cash as opposed to having to sell the property itself," said Young, 53, of Upper Township.
The most likely candidate for a deed in lieu transaction, he said, is a homeowner who's underwater - owing more than the house is worth - on a property with no liens on it.
Young said banks acquiring a property through deed in lieu would become subject to such liens, for example coming from a second mortgage, and are reluctant to deal with that exposure.
Schroeder said the typical candidate for a deed in lieu is someone who has tried to sell the property for enough to cover their mortgage and then, failing that, in a short sale. If even then they weren't able to get an offer for the house that was acceptable to the lender, the lender might express interest in a deed in lieu exchange.
Banks are careful, however, to make sure the homeowner can't afford the mortgage and "isn't just strategically defaulting, not just sitting on cash, looking to walk away and buy another house," he said. "That's rare but it does happen."
So the lender will require tax returns from two years, payroll slips or unemployment checks, for example, as proof of the mortgage holder's financial situation.
Homeowners who think they might be candidates for deed in lieu shouldn't wait for lenders to call them, he said.
Once they realize they can't make their mortgage payments, they should start calling their lender regularly - the number's on the mortgage bill - to see if programs are available that could help them.
"Call on a regular basis, because there could be new programs. Don't bury your head in the sand just because it's debilitating to think about it," Schroeder said.
The other thing people defaulting on a mortgage need to realize is that they are in breach of the largest contract they're likely to sign in their life and should have legal counsel to ensure that their rights are protected in the resolution of that breached contract, he said.
That gets the attorney in position to handle the deed in lieu if that's the best alternative.
A deed in lieu settlement still lowers the homeowner's credit score, Schroeder said, typically by 200 to 300 points. But if that person regains their financial footing once they no longer need to make the large mortgage payment, they can regain good credit in two to three years - generally sooner than with a foreclosure and bankruptcy.
Three years is also how long after a deed in lieu that someone must wait before becoming eligible again for a Federal Housing Administration-insured mortgage, he said, the same as with a foreclosure.
The most recent data from RealtyTrac, the online foreclosure information service, shows sales of such distressed properties in the area were down substantially in the third quarter as a result of court delays in processing.
In Atlantic County, there were 114 sales of foreclosed properties, just 11 percent of the total property sales in the three months ending Sept. 30. Nationwide, foreclosures accounted for 20 percent of sales during the period.
Foreclosure sales in Atlantic County also were down 41 percent from the same quarter a year ago, but are likely to rebound since New Jersey's courts in the fall allowed foreclosure processing to resume.
Cape May County's 41 foreclosure sales were likewise down 41 percent from the year before, and Ocean County's 168 sales were 47 percent lower. Cumberland County showed no foreclosure sales for the quarter in the RealtyTrac data, compared to 37 sales in the period a year ago.
As one of the approximately half of all states in which foreclosure is a judicial matter, New Jersey's foreclosure sales dropped 37 percent in the quarter to 2,255, compared to a nationwide decline of just 5 percent to 221,536.
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