TO DILF or not to dilf: That is the (forclosure) question

By Sally L. Galati, Esq.

The good news: Nevada and Las Vegas again reach new heights! The bad news, however, is that in this case, the reference is to foreclosure statistics. In its October 2007 report of foreclosure statistics across the nation, RealtyTrac cites Nevada’s total foreclosure activity as the eighth highest in the country for the month, with 6,618 foreclosure filings.¹ This number represents a twenty percent increase over September, and an almost 200% increase over October 2006.

Worse yet, Nevada’s foreclosure rate, with one homeowner filing for foreclosure out of every 154 households, is the highest among all states—for the tenth month in a row, according to RealtyTrac’s report. Clark County managed to top even that number by posting a foreclosure rate of one filing for every 120 households in the county. The national foreclosure rate was one foreclosure filing for every 555 households during October 2007.

Real estate professionals need to understand not only the present foreclosure statistics, but also the alternatives to foreclosure, to better position themselves and their clients during this harsh economic time and in the recovery period that is certain to follow.

Deeds in Lieu of Foreclosure

A Deed in Lieu of Foreclosure (“DILF”) is fairly simple in concept. A borrower/ homeowner facing certain foreclosure voluntarily gives the deed to the property to the lender. The lender would then take possession of the property and sell it to recover at least a portion of the amount lent to the borrower. Beyond the simple concept, however, there are benefits and concerns that should be considered by each side to any DILF transaction prior to determining whether this option is best for the borrower.
DILF Benefits

There are several benefits that accrue to the borrower through use of a DILF. First and foremost, if foreclosure is imminent, the DILF process allows the borrower to avoid the hassle and embarrassment of a foreclosure proceeding. Once the lender accepts the DILF, the borrower washes its hands of the deal, and is free to walk away. Additionally, if the lender agrees to accept a DILF, it does so in exchange for releasing the borrower from any deficiency that might result if the market value of the property is less than the amount owed on the note. In other words, the borrower is no longer obligated to pay the lender for any loss in value on the property.
From the lender’s perspective, a DILF allows the lender to avoid a potential contentious foreclosure proceeding (and the associated costs and time delays) while resulting in the lender quickly obtaining the title to the property.

DILF Concerns

From the borrower’s perspective, a DILF shortens the time the borrower can remain in the property—once the DILF is given to the lender, the borrower no longer has an interest in the property, and must vacate. Contrast that with the additional time a borrower can stay in the property during a foreclosure proceeding, and he may be vacating the property a year or more than he otherwise would. Additionally, the borrower should consider the tax effect of utilizing a DILF: the IRS requires all lenders to send a 1099 Income Earnings Statement to the borrower for any forgiveness of debt in excess of $600.² Therefore, any borrower considering use of a DILF must consult with his tax advisor to determine the tax effects of such a transaction.

From the lender’s perspective, there are many risks to be considered, and the presence of any of the following risks may be enough for the lender to refuse to accept a DILF. Acceptance of a DILF means that the lender takes title to the property subject to all the liens and encumbrances on the property. Thus, if there are multiple lien holders involved, the lender would have to negotiate releases of the other liens to clear title. In that case, the lender would most likely prefer to commence a foreclosure proceeding, which by its nature would wipe out the subordinate liens.

An additional concern for a lender is the doctrine of merger. The common law doctrine of merger provides that if both title to a property and title to a mortgage on that property are held by the same holder, the mortgage, as a lesser interest, merges into the greater fee interest. As a result, the mortgage becomes extinguished, and any junior lienors are elevated to a higher priority security interest in the property. Because of this doctrine, lenders often include an anti-merger provision in the DILF, stating that the conveyance is subject to the mortgage.

Some states, including Nevada, consider the parties’ intent, especially one in whom the interests unite (here, the lender) to determine whether a merger has occurred; if merger is against that party’s best interest, it will not be deemed intended by the parties. And while there is not a lot of Nevada case law directly related to DILFs, the Nevada Supreme court held that merger is against a party’s best interests when that party’s deed of trust would lose its priority.³

For a borrower facing the stark reality of an impending foreclosure, a DILF may provide a better alternative under the right circumstances. The most promising DILF candidates are those with loans at or near the market value of the property, with no second mortgages or other junior liens against the property. For a real estate professional working with clients in Nevada’s tumultuous real estate market, knowing when and why to suggest a DILF as an alternative to foreclosure might be exactly the kind of client service needed to help make a new start—and possibly future business in the topsy-turvy real estate market called Las Vegas.

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¹http://www.realtytrac.com , last accessed December 16, 2007 .

²http://www.cccssacto.org/mortgage/workout , last accessed November 21, 2007 .