What Happens to Your Equity in Foreclosure?

What Happens to Your Home Equity in Foreclosure?

If you have any home equity remaining after the lender sells your home, the lender will return your equity minus their expenses, including missed payments and late fees. Keep in mind, when a lender forecloses on a home, they generally put the home up for auction. Because foreclosed properties are sold "as is" with no opportunity for buyers to inspect them beforehand, they often fail to sell. Those that do often go for much less than their market value.

As a result, many foreclosed homes end up with negative home equity, with no sale proceeds returning to the buyer. However, if the home doesn't sell at auction, the property becomes "real-estate owned," meaning the lender owns the property and can sell it through a real estate agent.

Here's an example scenario to help paint a clearer picture of what happens to your home equity in foreclosure. Say you purchase a house for $300,000 with a 20% down payment, or $60,000. Assuming there are no other liens or mortgages against your property, you initially have $60,000 in home equity. Over time, you make payments and perhaps your home increases in value. Your home is now worth $350,000 with a mortgage balance of $200,000, leaving you with $150,000 in home equity.

Unfortunately, in this example, you experience a financial downturn, such as a loss of income. Without adequate income, you fall behind on your payments, leading the bank to foreclose on your home. If your lender auctions or sells your home for less than your $200,000 balance, you won't receive any money back. But if the bank sells your home for, say, $300,000, you could recover $100,000 of your home equity, minus your lender's expenses like foreclosure costs, back mortgage payments and late fees.

How Foreclosure Costs Impact Your Equity

As mentioned, your lender must return any remaining home equity to you after deducting their costs, including the following:

• Late fees: Late fees on your missed payments can vary by state but typically range from 4% to 5% of your outstanding payment balance. So if your monthly payment is $1,200 and your bank charges a 5% late fee, you could owe $60 for your first missed payment (5% of $1,200). However, your fees could rise to $120 (5% of $2,400) and $180 (5% of $3,600) if you also missed the following two payments.
• Missed payments: Your lender also has the right to recoup any back payments owed on the property. Try to catch up on missed mortgage payments if possible because each missed payment increases your overall debt and reduces the amount of equity you might receive if your home is foreclosed.
• Foreclosure process costs: The foreclosure process typically results in significant costs for mortgage lenders. Costs typically include attorneys or trustees fees, title costs, sheriffs fees and administrative costs like filing and recording fees.
• Low appraisal: Lenders usually don't like to keep foreclosed properties on their books and often price these properties below market value to facilitate a faster sale. Of course, selling your home at a significantly lower cost eats into the proceeds, including your home equity.
• Homeowners insurance: If your homeowners insurance policy has lapsed, the lender will likely purchase coverage, which is called "force-placed" insurance. Since your mortgage likely requires you to keep homeowners insurance on the property, the lender will add the cost of insurance to your account.

How to Avoid Foreclosure

As demonstrated, foreclosure can be an expensive process that could result in losing some or all of your equity. Not to mention, a foreclosure can seriously harm your credit for seven years. As such, foreclosure should be avoided if at all possible.

Here are some tips to help avoid foreclosure:

• Ask your lender for help. One of the biggest mistakes you can make if you're behind on payments is to ignore the problem. Contact your lender as soon as possible to discuss the options available to you. Often, it's more financially advantageous for a lender to work with you to resolve your back payments than to foreclose and sell your home well below its market value.
• Get counseling. If you're having trouble managing your mortgage payments, consider getting free or low-cost counseling through the U.S. Department of Housing and Urban Development (HUD). A HUD-approved housing counselor can explain your options, organize your finances and even help you negotiate with your lender.
• Consider financing options. Other options that could help you avoid foreclosure include refinancing your mortgage or modifying your current home loan. You also might be eligible for mortgage assistance.
• Sell your home. Selling your home is a tough decision, but it might make sense if it helps you steer clear of foreclosure. Run the numbers to see if sale proceeds would be sufficient to catch up on your mortgage debt. Consider talking with your financial advisor or a HUD-approved counselor to get specific advice for your situation.
• File for bankruptcy. A Chapter 13 bankruptcy could help you satisfy your mortgage debt and keep your home. Keep in mind, however, that bankruptcy is generally considered a last resort option due to the severe financial and credit consequences that come with it.

Keep an Eye on Your Credit During Foreclosure

Foreclosures remain on your credit report and drag down your credit scores for up to seven years. As such, make every attempt to make your payments on time to avoid foreclosure. As you do, consider watching your credit with Experian's free credit monitoring to make sure everything is being reported correctly.

If you're already in foreclosure, understand the negative impact on your credit will decrease with time. Take steps to improve your credit, and eventually, you could qualify for new credit, including another mortgage.