HUD Home Title Issue "Deed in Lieu of Foreclosure"

5 Replies

I wanted to share my experience with a recent HUD Home I purchased to BRRRR. It was a condo, purchased for $185k and the ARV was $250k. There were three comp sales in the complex in the past 6 months so that $250k was apparent.

The rehab cost $20k and the property appraised for $253k.  During the title search for the refi, the bank caught something that I knew all along but didn't think anything of...that the previous owner left a lot of money on the table.

The previous owner signed over the property to HUD in a "deed in lieu of foreclosure" transaction. Basically they agreed to hand over the keys to HUD and HUD agreed to extinguish the debt instead of pursuing the foreclosure. The thing is the mortgage at the time was $135k. Why would you hand over the keys when there was plenty of equity in the property? It was worth $250k with just a light rehab. I could never figure that out.

Anyway, the bank focused on that $50k in equity, the difference between the debt extinguished ($135k) and what I paid ($185k).  Bankruptcy law says that equity could be later be deemed a fraudulent conveyance if the previous owner were to file bankruptcy in the future.  Just imagine you lent that person $25k and they file bankruptcy and can't pay you back.  But then you find out they had $50k in equity in their home that they just walked away from that could have been realized and paid off your loan.  That's what the bank was nervous about.

Luckily the title insurance policy that I purchased when I bought from HUD said they'd cover that scenario if they were to file bankruptcy in the future. So I'm covered but it was a stressful few days while the lender and title insurance company went back and forth.

I'm noticing more HUD Homes are being acquired in this "deed in lieu" transaction as opposed to the traditional foreclosure route. This scenario is likely rare because most of these properties are under water. But I wanted to provide a heads up to other HUD Homes might want to check if it was acquired in a "deed in lieu" and if there was equity left on the table.

@Greg H. have you come across this or other title issues with HUD Homes?

Interesting and no I have never witnessed this scenario. I would assume this would come into play in states where it is a more difficult process to foreclose. Texas is non-judicial and quick so I would not imagine a lender would rather go the Deed in Lieu route. 
My question would be, was the deed in lieu To HUD or the bank that then conveyed to HUD?

@Greg H.

The property is in Massachusetts so the process is much lengthier which is why we’re seeing more deed in lieu transactions.

The transfer was directly to the Secretary of HUD, not to the bank.

That is a non issue.  A deed in lieu of foreclosure is a legitimate way for someone to get rid of their debt. The claw-back provisions of bankruptcy only go back a limited time (6 months I think). It probably took the bank that long to get it back on the market to sell it to you. Also the title insurance you should have purchased when you bought would cover this anyway.

The potential problem with deed in lieu of foreclosure is if the owner has other debt like judgements that attach to the property.

@Tom Gimer care to comment?

@Ned Carey One of the required elements of a DIL transaction is that the mortgage balance exceeds the property’s current value. Behind the scenes in a properly conducted DIL transaction is a legitimate borrower request to reconvey, appraisal, and written agreement that ensures the transaction meets the criteria. HUD should never have taken title this way. 

Covered risk 9 in the standard ALTA owners policy protects a subsequent buyer in this scenario, but it would not protect HUD who would be dealing with exclusion #4. They should know better as this isn't even borderline.

@Tom Gimer

Thanks for the insight. This certainly wasn't a case where the mortgage exceeded the property value. As we know, HUD conducts their "as is" appraisal and lists for that amount. In this case it was listed for $225k.

And obviously that was the bank’s concern that the previous owner put themselves in a worse financial situation where bankruptcy might now be closer.

The DIL has language where the previous owner asserts that they are solvent, etc. but I know a bankruptcy trustee would look to this transaction first as a way to clawback funds.

As you pointed out, in the end the title policy does cover it.

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