What it means
When a borrower stops paying a mortgage, the lender can start foreclosure, which is the legal process of taking and selling the property to recover the debt. A voluntary approach means the borrower stops resisting and agrees to a negotiated exit.
The lender saves legal costs and time, and the borrower avoids the stress of a drawn-out court case. There are several forms.
The borrower may sign a deed in lieu of foreclosure, transferring the property directly to the lender. Alternatively, the parties may agree a consent judgment or a short sale, where the property is sold for less than the debt with the lender's approval.
Lenders often prefer these routes because foreclosure can take many months and cost a lot in fees, upkeep and lost interest. A property left empty can also deteriorate, which reduces its resale value.
If the numbers show that a cooperative exit leaves the lender better off, it is likely to accept. For the borrower, the key question is what happens to the shortfall, known as the deficiency, which is the difference between the debt and the sale proceeds.
Some agreements release the borrower fully, while others let the lender pursue the balance. Whether a deficiency can be claimed depends on the agreement and local law, so it should be settled in writing.
The credit effects vary. A voluntary exit still shows up on a credit record and can make future borrowing harder, though it is often viewed as less damaging than a forced sale.
Tax can also arise if part of the debt is cancelled, so the borrower should take advice. Voluntary foreclosure is different from simply walking away.
Abandoning a property without an agreement leaves the borrower liable for the debt and for any damage or charges, and the lender can still foreclose and pursue the balance.
In practice
Real-world examples.
Example
A couple whose small business has failed can no longer pay their $280,000 mortgage. They contact the bank and agree to sign the home over under a deed in lieu. The bank accepts, releases them from further liability, and sells the home within a few months.
Example
A commercial landlord with a half-empty shop unit negotiates a short sale with its lender. The unit sells for 90% of the loan amount, and the lender writes off the balance as part of the settlement. Both sides avoid a lengthy court hearing.
Example
A homeowner moves overseas for work and cannot rent out her house at a price that covers the mortgage. She offers it back to the lender through a consent agreement. The lender takes the property after confirming there are no other charges against it.
Formula
Calculation
Deficiency = Total debt owed - (Sale proceeds - Costs of sale)
A borrower owes $350,000 in principal plus $10,000 in unpaid interest and charges, so total debt is $360,000. The property is sold for $320,000, and selling costs are $20,000. Net proceeds are $320,000 - $20,000 = $300,000. Deficiency = $360,000 - $300,000 = $60,000. Whether the borrower must pay this $60,000 depends on the agreement and local law.Case study
Seen in the real world.
Birchwood Bakery Holdings is an illustrative, fictional company that owned its bakery premises with a $520,000 mortgage. After a flood closed the shop for months, it fell three payments behind.
The lender estimated that a contested foreclosure would take about 14 months and cost $60,000. The finance director proposed a voluntary exit, in which Birchwood would hand over the premises, valued at $480,000, and the lender would release the company from the remaining $40,000 balance.
The lender agreed because the cooperative route saved it $60,000 in costs and avoided lost interest. The illustrative result left Birchwood free of the debt and able to restart in rented space, though its credit record showed the event for some years.
Watch out
Common mistakes.
- Walking away from the property without a written agreement, which leaves the borrower liable for the debt and any damage.
- Assuming the lender must accept a voluntary exit, when the lender will do so only if it improves its position.
- Ignoring the possibility of a deficiency claim or a tax charge on cancelled debt.
Questions
People also ask.
What is the difference between voluntary and involuntary foreclosure?
In an involuntary case the lender sues and the court orders the sale, while a voluntary case is agreed between the parties without a contested hearing.
Will I still owe money afterwards?
That depends on the written agreement and local law, which may release you or allow the lender to claim the shortfall.
Does it damage my credit?
It usually appears on a credit record, though the effect is often seen as less severe than a full court-ordered foreclosure.
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