Many people think that if they get into financial trouble on a project, they can give their lender the mortgaged property, wash their hands of the whole mess, and simply walk away with only the loss of their earnest money and time. Unfortunately, this is not the way things work. The mechanism of giving property to a lender, without the trauma of a foreclosure, is called a deed in lieu of foreclosure. Most insiders simply refer to it as a deed in lieu.
The first problem with a deed in lieu is that lenders do not like them, especially if you have been remodeling or making repairs to the property. When a lender gets a deed in lieu, the lender has to take the property subject to all other liens and claims on it, which includes those that could be made by your subcontractors and suppliers. No lender wants to get stuck with additional liens or claims on a piece of property.
The second problem with a deed in lieu is that it does not necessarily wipe out your loan. The rules vary from state to state, and also according to your negotiations with your lender. You could easily suffer the loss of the real estate and still owe a very large sum of money to the bank. The reason for this is because the lender will give you credit for less than the fair market value of the house in its current condition. Half-finished houses have fairly depressed values, which is why successful flippers are able to make a profit on the pieces of property. The lender gives a credit less than the fair market value, so it has a cushion in case it estimated the value incorrectly, as well as to cover itself for holding costs until it can sell to someone else. The same analysis goes into calculating a bid price for a foreclosure. As a result, giving the house back to the bank, or letting it go to foreclosure, will usually not solve any problems and will probably cause more.
In very rare circumstances, you may be able to negotiate what is called a non-recourse note. This means that the lender agrees to loan you money secured by real estate, but also agrees to look only to the real estate for recovery of its loan in case you default. In other words, the lender agrees in advance that it will not sue the borrower after a default, but simply foreclose on the real estate. Successfully negotiating non-recourse notes are almost always to long-term financing on large income-producing properties like apartments, office buildings, and shopping centers.
Sometimes, so called hard money lenders will loan you 50% of the value of real estate on a non-recourse basis and at high interest rates. It would be extremely difficult to find a flip that qualifies. You should not waste your time going from lender to lender to lender, hunting for the elusive non-recourse financing for your house flip.