This article reviews a lender’s bargain for a deed-in-lieu to avoid the delay and expense of a foreclosure.


Reducing the risk of loss

The trustee’s foreclosure of a junior trust deed by a carryback seller or an equity lender may leave them unable to recover all the monies due them on the note. The same holds true for a first trust deed lender who originates a loan with a high loan-to-value ratio (LTV). [See Chapter 30]

Rather than initiating a trustee’s foreclosure sale when an owner is in default, a prudent lienholder will consider saving the considerable costs of foreclosure and lost time by negotiating with the property owner for a deed-in-lieu of foreclosure.

Editor’s note — The following deed-in-lieu rules also apply to the termination of the buyer’s rights of redemption under lease-options sales and land sales contracts.

The deed-in-lieu is an exchange

A deed-in-lieu is prepared on the same grant deed form used for the conveyance of fee title. [See Form 406 accompanying this chapter]

Under a deed-in-lieu, an owner of property essentially sells his property and conveys it to a carryback seller or lender in exchange for the seller or lender canceling the debt secured by their trust deed lien on the property.

To complete the exchange, both the deed-in-lieu and a reconveyance of the trust deed are recorded, thus extinguishing the lender- borrower relationship between the holder of the trust deed and the owner of the property.

Before completing the exchange, the seller or lender negotiating for a deed-in-lieu of foreclosure must consider the effects of title insurance, purchase options, due-on clauses, reassessment and tax aspects of the property transfer in exchange for cancellation of the debt.

Deed absolute vs. mortgage

For a deed-in-lieu to function as a deed absolute, the transaction must be a fair exchange of values, a conveyance of all an owner’s interest in a property for a trust deed holder’s complete cancellation of a debt. Thus, the owner agrees to a deed-in-lieu of foreclosure when he has little or no measurable dollar amount of equity in his property in excess of the liens.

Conversely, a deed-in-lieu does not function as a deed absolute, but as a mortgage-in-fact when the owner executing the deed-in-lieu retains the right to:

· cure his default and have the property reconveyed to him at a later date;

· receive a payment of surplus net proceeds if the lender later resells the property; or

· continue in possession of the property under a lease and purchase option. [See Chapter 19]

A voidable deed-in-lieu

A deed-in-lieu (or quit claim deed) handed to a trust deed holder in advance of a default is voidable by the owner of the property who signed the deed. If the premature delivery of the deed-in-lieu to the trust deed holder is for the purpose of eliminating the owner’s reinstatement and redemption rights, the deed-in-lieu will be set aside as void. [Hamud v. Hawthorne (1959) 52 C2d 78]

Occasionally, at the time a trust deed lien is recorded or later modified, a deed-in-lieu is concurrently entered into by the owner, then notarized and delivered unrecorded to the lender or carryback seller. Later, the deed-in-lieu will be recorded when a default occurs. However, once recorded, the deed- in-lieu functions as a mortgage, not a conveyance. The recorded deed-in- lieu replaces and extinguishes the existing trust deed. Thus, the deed-in-lieu becomes a mortgage-in-fact that replaces the now extinguished trust deed.

The delivery of a deed-in-lieu in advance of a default is an invalid waiver of the redemption rights an owner holds under any debt secured by his real estate. Thus, on a default after a beneficiary has received a deed-in-lieu, a judicial foreclosure is forced on the lender or carryback seller who records the deed-in-lieu to clear title in his name, since recording an ineffective deed-in-lieu creates a mortgage without the benefit of a trustee’s foreclosure provision. [Calif. Civil Code §2889]

Necessary title insurance

On recording a deed-in-lieu, a title insurance policy is needed to assure the junior lienholder that the title he receives on the conveyance is clear of any liens or other types of encumbrances which might have attached to the property. Also, the property may have been conveyed by the owner after the junior lienholder’s trust deed was recorded.

When any encumbrance exists on a property which is junior in time to the foreclosing seller’s or equity lender’s trust deed, a deed-in-lieu conveys title subject to that lien.

Thus, a carryback seller cannot accept a deed-in-lieu and reconvey his trust deed if junior liens or conveyances which affect the title of the property were recorded at a later date. If the title has been further encumbered or conveyed after recording the trust deed, the carryback seller must foreclose to clear title to the property in his name.

Title insurance companies view a deed-in-lieu with suspicion, since the deed may be voidable. Thus, special wording is required to signify the deed is a true conveyance, not a disguised mortgage with a lease and option allowing the owner to recover title.

To be insurable, the deed-in-lieu must state the transfer was freely and fairly entered into by the owner for adequate consideration. The deed must also state the conveyance either fully or partially satisfies the debt. [See Form 406]

Additionally, the title insurance company may require an estoppel affidavit from the owner, containing similar assurances the deed-in-lieu is a deed absolute, not a mortgage-in-fact.

Incentive to stay or convey

An owner is more inclined to negotiate a deed-in-lieu of foreclosure when his gross equity is less than 10% of the property’s current fair market value. Additionally, the trust deed holder will probably take a loss on the foreclosure and resale of the property if the owner’s equity is less than 10% of the property’s current fair market value.

However, when the owner has little or no equity to lose, the trust deed holder may need to offer some greater incentive beyond cancellation of the trust deed in exchange for the title of the property. One incentive the trust deed holder may offer for a deed- in-lieu is a relatively small amount of “move-out” cash which is acceptable to the buyer, in addition to erasing the debt.

The incentive to enter into a deed-in-lieu may also include non-cash considerations, such as an agreement which permits the buyer to continue occupying the property after the conveyance solely as a holdover tenant.

Editor’s note — An option to repurchase accompanying the right to retain possession of the property under a lease may not be granted to the buyer, as it would convert the deed-in-lieu into a mortgage. [[Calif. Code of Civil Procedure §744]

The seller must weigh his money expenditures required to complete a foreclosure against the amount of cash or other forms of consideration he is willing to offer the buyer to receive a deed- in-lieu and possession of the property in order to avoid a delay in repossessing the property. [See Form 406]

Due-on-sale triggered

For a junior lienholder, taking title to real estate by a deed-in- lieu is like receiving a trustee’s deed on foreclosure, since both trigger any due-on-sale clauses in the senior trust deed.

Whether repossessing property by foreclosure or a deed-in-lieu, the carryback seller or junior lender should consider negotiating a waiver of the underlying lender’s due-on-sale enforcement rights before reinstating the lender’s trust deed loan. [See Chapter 28]

Profit reporting consequences

Unlike money lenders, carryback sellers who take back the property they sold, either at the trustee’s sale or by a deed-in-lieu, cannot report a profit or loss on the exchange of the canceled carryback note for title to the property.

However, the tax consequence of the original sale in which the carryback paper was created is re-analyzed. Taxwise, any portion of the down payment and principal paid in the installments which were not previously taxed are now taxed on his repossession of the property. [Internal Revenue Code §1038]


Whether a seller obtains title through foreclosure or a deed-in- lieu, a change of ownership occurs which calls for a reassessment of the property.

The property will be reassessed at its current market value on receipt of a deed-in-lieu or a trustee’s deed.