Falling behind on HELOC payments can have serious consequences, including foreclosure. Learn what to do if you cant make payments on your HELOC.
Foreclosure can be a stressful and uncertain time for homeowners. If you have a home equity loan or line of credit in addition to your primary mortgage you may be wondering what happens to that debt if your home goes into foreclosure. Let’s break it down.
An Overview of Home Equity Loans
A home equity loan allows you to borrow against the equity in your home. Equity is the difference between what your home is worth and what you owe on your mortgage. For example, if your home is worth $300,000 and you have $200,000 left on your mortgage, you have $100,000 in equity.
With a home equity loan, you’re essentially using your home as collateral to secure the loan. The lender can place a lien against your home, meaning they have a legal right to take possession of the home if you default on the loan.
Home equity loans often have lower interest rates than other types of consumer loans since they are secured by your property But they also carry risk – if you can’t repay the loan, you could lose your home.
How Foreclosure Impacts Home Equity Loans
When you default on your primary mortgage and the lender forecloses, any secondary loans like a home equity line of credit (HELOC) are also affected. Here’s a quick rundown of what happens:
-
The primary mortgage lender gets first dibs on any proceeds from the foreclosure sale. This makes sense since the primary lender’s claim on the home came first when you bought it.
-
If there are any funds left after the primary lender has been paid in full, the secondary lenders (like the HELOC lender) get paid next.
-
If the foreclosure sale does not generate enough funds to satisfy both the primary and secondary loans, the secondary lenders often get nothing.
-
Even if there are additional funds available after both loans are paid, the lender can deduct expenses like legal fees, missed payments, penalties, etc. before returning any equity to the borrower.
When Might a Lender Foreclose on a HELOC?
Given their junior position, HELOC lenders don’t always pursue foreclosure if the primary mortgage goes into default. It depends largely on how much equity exists in the home.
If there is significant equity beyond the primary mortgage balance, the HELOC lender has an incentive to foreclose so they can get repaid from the sale proceeds.
But if the outstanding loans exceed the market value of the home, the HELOC lender probably won’t foreclose. At that point, it’s an unsecured loan so foreclosure is pointless. They would have to pursue other options, like suing the borrower for repayment.
As a general rule, the more equity in the home, the more likely the HELOC lender will opt for foreclosure. But it’s not guaranteed.
Strategies to Protect Your Home Equity
Now that you understand the implications of foreclosure on home equity loans, here are some tips to avoid this outcome:
-
Prioritize your primary mortgage payments. Make these a top budget priority to prevent default on your first lien. This will buy you time to address the HELOC if needed.
-
Communicate proactively with lenders. Don’t ignore calls or letters from your lenders. Talk to them right away if you anticipate problems making payments.
-
Consider loan modifications. You may be able to modify the terms of your loans to reduce payments to a manageable level. This can help avoid foreclosure.
-
Explore consumer credit counseling. Nonprofit counseling agencies can help analyze your budget and negotiate with lenders on your behalf.
-
Sell your home. This is a tough choice but may be better than losing everything in foreclosure. Consult with a financial advisor to understand all your options.
-
File for bankruptcy. Chapter 13 bankruptcy stops foreclosure proceedings and allows you to repay debts under court protection. Chapter 7 bankruptcy liquidates assets to eliminate debts but allows you to keep exempt property. Consult an attorney to see if this strategy makes sense for your situation.
The bottom line is foreclosure puts your home equity at substantial risk. But proactive steps like communicating with lenders early, considering loan modifications, and understanding all your options can help protect your wealth and avoid foreclosure altogether.
Frequently Asked Questions About Home Equity and Foreclosure
Many homeowners facing foreclosure have questions about what will happen to their built-up home equity. Here are answers to some commonly asked questions:
Does the lender take all your equity in a foreclosure?
No, the lender cannot legally keep your equity if the foreclosure sale generates surplus funds after repaying your mortgage balance and foreclosure fees. Any remaining proceeds must be returned to you as the homeowner. However, the foreclosure process often consumes equity.
Can a home equity loan foreclose separately from the first mortgage?
Legally, no. The primary mortgage lender has to initiate foreclosure first. The home equity lender cannot foreclose unless the first mortgage lender completes foreclosure or abandons the process.
What if you have no equity – will the lender still foreclose?
If the home is underwater (you owe more than it’s worth), the lender probably won’t foreclose on a home equity loan alone. With no equity to claim, foreclosure would not benefit the lender. They would have to pursue other options like suing for repayment.
Does bankruptcy wipe out a home equity loan?
Maybe. Filing Chapter 7 bankruptcy can eliminate secondary loans like HELOCs through the debt discharge. Chapter 13 bankruptcy allows you to catch up on payments under a court-approved repayment plan, so the debt would not be eliminated but you could avoid foreclosure.
Can you reaffirm (keep paying) a home equity loan in Chapter 7 bankruptcy?
Yes, you can voluntarily reaffirm the debt and keep making payments. However, there is usually no advantage to doing this since HELOC debts are typically dischargeable in Chapter 7. Consult a bankruptcy attorney to understand the implications.
What should you do if facing foreclosure?
First, don’t ignore letters and calls from your lender. Communicate proactively to explain your situation and discuss options. Consider loan modifications, consumer credit counseling, bankruptcy, and other strategies. If all else fails, selling the home may be better than losing everything to foreclosure.
In Conclusion
Government assistance with HELOC payments
The Homeowner Assistance Fund (HAF) is a federal program that aims to help families at risk for foreclosure. Requirements for HAF resources vary by state whether it covers home equity loans and HELOCs.
The home foreclosure process
When a payment is one month late, the lender will usually inform the borrower and add penalties or late fees to existing charges. After two months of missed payments, the lender will likely start trying to make direct contact with the borrower. Often the borrower will be offered options to help them get caught up on payments or at least not fall further behind.
Finally, after 3 or more months of missed payments, if the lending institution is unable to negotiate with the homeowner, a “demand letter” will be sent which notifies the debtor of their outstanding balance and gives 30 days for the account to be paid up to date. Following the demand letter, a notice of default is sent, which marks the beginning of the foreclosure process.
If there is sufficient equity in the home, its likely that lenders will choose to foreclose because they have a chance of recovering some money after the first mortgage is paid off. However, if the homeowner is underwater—meaning their home is worth less than what they owe—then lenders may be less likely to foreclose because they wont receive any money after repossessing the property.
In general, lenders are usually more eager to foreclose when homeowners still have considerable equity in their homes. Foreclosure costs can often be too high for lenders if there isnt enough value in the property for them to recoup any funds even after paying off the existing debt load. Fortunately for those who are struggling with payments on a home equity loan or HELOC, lenders wont always automatically initiate foreclosure proceedings and may instead offer other options such as forbearance or loan modification programs that could help borrowers avoid foreclosure altogether.