What Happens If You Default on a Home Equity Loan?

Taking out a home equity loan or home equity line of credit (HELOC) can seem like an easy way to get quick cash by borrowing against the equity in your home. But what happens when you fall behind on payments or default completely? Unfortunately the consequences can be severe, potentially resulting in foreclosure, lawsuits wage garnishment, and lasting damage to your credit.

An Overview of Home Equity Loans and HELOCs

Before diving into the ramifications of default let’s quickly review what home equity loans and HELOCs are

• Home Equity Loan – This is essentially a second mortgage with a fixed interest rate and set repayment terms, usually over 5-15 years. The loan amount is a lump sum that you receive upfront.

• HELOC – A home equity line of credit operates more like a credit card, with a variable interest rate and draw period where you can access funds as needed. Then a repayment period kicks in where you can no longer draw and must pay back the balance over time.

In both cases, these products allow you to leverage the equity built up in your home to receive cash now for various uses, from home improvements to debt consolidation. As second liens, they are riskier than first mortgages, so interest rates are higher, but still tend to be lower than other types of financing like personal loans or credit cards.

Foreclosure is the Biggest Risk of Default

Home equity loans and HELOCs are secured by your property, meaning if you default the lender can potentially take your home through foreclosure. With first mortgages, lenders usually pursue foreclosure only as a last resort when other options like loan modifications have failed. But second lien holders may be quicker to foreclose.

The foreclosure process can take anywhere from several months to over a year depending on state laws. Once complete, you will be evicted from the home and your property sold at auction. The first mortgage lien will be paid first from the sale proceeds. If any money remains, it goes to the home equity lender. You’re also liable for any debt not recovered through the sale.

Foreclosure devastates your credit score and can make it very hard to qualify for financing in the future. You may also have a difficult time finding landlords willing to rent to you afterwards.

Home Equity Lenders Can Sue for Repayment

If you have significant equity in your property, foreclosure is probably the route your home equity lender will pursue in case of default. But if your home value has dropped and you have little to no equity left, the lender may decide it’s not worth initiating foreclosure proceedings since the sale is unlikely to yield any money to repay them after the first mortgage.

Instead, they can opt to sue you directly for repayment of the loan amount owed. While this spares you from losing your home, you aren’t off the hook. Through the courts, creditors can potentially garnish your wages, put liens on your other assets, or levy your bank accounts.

Lawsuits are also damaging to your credit profile and can make it very difficult to get loans or credit cards in the future. You may even have trouble opening a basic checking account at some banks after a court judgment.

Act Quickly to Communicate with Your Lender

To avoid foreclosure or legal action if you default on a home equity loan or HELOC, it’s critical to contact your lender right away and explain your situation. Many lenders want to work with borrowers who have hit hard times, but they are less likely to show flexibility if you’ve made no effort to get in touch and have ignored their attempts to discuss repayment options.

Your lender may be able to offer:

• Loan modification – Adjustments to the interest rate, loan term, or monthly payment to make it more affordable.

• Repayment plan – A structured schedule to catch up on missed payments over time.

• Deferments – Temporarily stopping payments for a defined period if you’re experiencing a hardship like job loss.

• Forbearance – An arrangement to reduce or suspend payments for a limited time. Interest still accrues.

• Refinancing – If interest rates have dropped, refinancing your home equity loan or HELOC at a lower rate could help. But refinancing costs money upfront.

• Hardship Programs – Some lenders like credit unions have specialized assistance for borrowers facing financial challenges.

The earlier you reach out, the more solutions may be available before the lender begins collections processes or legal proceedings. Communication and good-faith efforts to get on a repayment plan whenever possible are key.

Government Relief Options are Very Limited

Historically, the government offered some temporary mortgage relief programs in response to economic crises, like the Home Affordable Refinance Program (HARP) during the 2008 financial crash. However, there are currently no broad government programs to help homeowners specifically with home equity loan or HELOC defaults.

Some limited options that may provide general help include:

• Mortgage assistance programs – Offered by a few private lenders and state housing agencies, these can provide temporary payment relief or modifications for homeowners struggling with their primary mortgage and other housing expenses.

• Mortgage Credit Certificate (MCC) programs – State and local programs that allow qualifying borrowers to claim a federal tax credit for a portion of their mortgage interest paid, providing some savings.

• Making Home Affordable – A HUD program with resources and tips for discussing your situation with lenders to seek workout options. The key is being proactive.

But in most cases, your primary recourse will be working directly with your home equity lender. Avoiding default in the first place should be the priority if at all possible.

Weigh Options Carefully Before Taking Out Home Equity Debt

While home equity loans or lines of credit can provide useful funds for home renovations, debt consolidation, and more, they also put your property at risk in case of default. Think carefully and run the numbers before taking on this additional liability.

Ask yourself:

• Is this purchase or project truly essential at this time? Is there another way to finance it?

• If my income dropped due to job loss or disability, could I still afford the monthly payments?

• Am I comfortable with the prospect of losing my home if I default?

• Have I allowed a sufficient emergency fund cushion in case of unexpected expenses?

If you use home equity debt responsibly within your budget, it can be an affordable financing tool. But proceeding with caution is wise, as defaulting can quickly snowball into foreclosure, lawsuits, and long-term financial damage if you over-leverage your property. Consider all options to avoid finding yourself in that situation.