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Because of the voluntary nature and cost-efficiency of the deed in lieu foreclosure, this type of transaction is often a win-win situation for the borrower and lender. When deciding whether to accept a deed in lieu of foreclosure, the first question that a lender typically asks is whether there are any subordinate liens attached to the secured real property. Since a foreclosure generally extinguishes subordinate liens and a deed in lieu of foreclosure does not extinguish such interests, in a case where there are subordinate liens, a lender often faces the tough decision whether to accept a deed in lieu of foreclosure. It must balance the costs and benefits between negotiating with the holders of the subordinate liens in order to proceed with a deed in lieu of foreclosure versus foregoing the deed in lieu of foreclosure in favor of a foreclosure proceeding. While the existence of subordinate liens is an important consideration, there are other important factors that a lender should consider during the deed in lieu of foreclosure process. There are circumstances where courts will set aside a deed in lieu conveyance, and the mere risk of such judicial scrutiny affects whether title to real property is insurable after a deed in lieu of foreclosure.

Another threshold issue that has an impact on the insurability of real property after a deed in lieu of foreclosure relates to the value of the secured property compared to the total outstanding indebtedness under the underlying promissory note. When the value of the real property that the lender is taking back by deed in lieu of foreclosure exceeds the total outstanding loan obligations of the borrowers, the deed in lieu of foreclosure transaction is susceptible to being set aside by a court. Even though the borrower is unlikely to challenge the deed in lieu of foreclosure after voluntarily conveying the real property to the lender, the difference between the value of the real property and the amount of outstanding indebtedness still poses problems for a lender from a bankruptcy point of view. In the event that a borrower were to file bankruptcy after completing a deed in lieu of foreclosure, a bankruptcy trustee could seek to avoid the deed in lieu transaction in order to capture the excess value of the real property to pay unsecured creditors. Because deeds in lieu of foreclosure are susceptible to being set aside by courts when the value of the property exceeds the amount of outstanding indebtedness, title insurance companies are reluctant to issue title insurance policies after deeds in lieu of foreclosure are completed in the absence of proof that the value of the real property does not exceed the amount of indebtedness. An affidavit from the borrower offering sworn testimony as to the value of the property compared to the indebtedness is usually sufficient to resolve insurability concerns.

Because of the risk of judicial scrutiny, insurability issues can also arise in a situation when the lender accepts a deed in lieu of foreclosure but does not release borrowers from responsibility for the underlying obligations under the promissory note. While insurability guidelines might vary from title insurance underwriter to title insurance underwriter and also could vary from state to state, the prevailing position of title insurance underwriters overwhelmingly appears to be that the note or other evidence of debt secured by the mortgage, security deed, or deed of trust should be cancelled and surrendered to the grantor.

There are many factors that can affect the insurability of title after a deed in lieu of foreclosure. Since each transaction is different, when questions arise, they should be handled on a case by case basis. However, considering the risks early in the process can prevent problems from arising and can prevent potential delays at REO.