What happens if I default on a home equity loan?

If you've taken out a home equity loan, you've obviously considered the what-ifs. We do this when considering financial issues. 

If an unlikely event has happened, first, take a deep breath. You always have options—some may work out better than you ever imagined. Here, we cover what to do if you fall behind on your HELOC payments. 

What should I do right now if I’m falling behind on my HELOC payments? 

You know that feeling when you realize you might have a financial problem? You can feel so alone, thinking you're the only person who's ever let it get this bad. Nothing could be further from the truth! Life happens, and it's not always possible to keep up with your obligations. 

Your first move is to speak with your lender. Call them and ask about hardship assistance. Be upfront about what's going on and let them know how important it is to you to get back on track. Don't be afraid to ask about all possible options, including refinancing and loan modifications. 

Most importantly, stay calm. You're going to be okay. Remember: A lender would often much rather work with you than foreclose on your property or sue you for the debt. Working with you creates a win-win situation. The loan is eventually repaid, and you get to stay in your home. 

Could I lose my house if I default on my second mortgage?

Yes, a lender could foreclose on your home and take possession if you default on the home equity loan, which is in fact a second mortgage. Taking out a home equity loan means borrowing against your house. But foreclosures cost money and time. Lenders usually won't do this until they’ve spent considerable effort encouraging you to get caught up on what you owe. They consider several factors. 

• Value of the home and how much equity is left. If your home is worth more than you owe, a lender is more likely to foreclose. If your home is worth less than you owe, the home equity loan lender won’t get much benefit from foreclosing.

• Lien priority. A lien is a legal claim to property. Your mortgage lender and your HELOC lender both have a lien on your home. That means if the home is sold, they get paid back before you get any money. The first mortgage lender gets repaid first. Then, if there’s enough money, the HELOC lender gets repaid. A HELOC lender may choose to sue instead of foreclosing if there would be little equity left after the first mortgage is paid off.

• Lawsuit. If the HELOC lender determines it’s their best chance of recouping their losses, they could sue you for the unpaid balance. 

What happens when a mortgage lender forecloses?

Foreclosure doesn't happen overnight and typically follows these steps:

• You're sent a notice of default, informing you of the missed payments and risk of foreclosure.

• There's a pre-foreclosure period during which you may have a chance to negotiate repayment (or sell the home to avoid foreclosure, if that's what you prefer).

• The foreclosure will happen.

• A public Notice of Trustee's Sale notice is posted, saying the property will be sold at a public auction.

• An auction is held, and the home is sold to recover the lender's losses. 

• If the home fails to sell at the auction, the lender takes ownership and the property falls under real estate owned (REO) status. REO status means the lender may list it for sale on its own. 

• If you remain in the home, you may be legally evicted. 

All along the way you’ve got chances to take steps to improve the situation before you lose the home. 

What can a HELOC default do to your credit?

Like most bills, late or missed HELOC payments are reported to credit bureaus and will probably lower your credit score significantly. The longer the loan is delinquent, the greater the damage to your score. 

It's possible to improve your credit score over time. In the meantime, you may have trouble qualifying for another loan when you need it. If you do qualify, you’ll pay higher prices compared to someone with good credit. As long as your score is low, lenders consider you a riskier borrower, so they charge more. 

Can I just walk away from a HELOC?

Walking away from a home equity loan may seem like the fastest way to regain peace of mind, but it could have serious financial consequences. The lender is still owed money, and foreclosure doesn't always wipe out the full debt. In many states, lenders can seek a deficiency judgment against you. Here’s how that works.

Let's say you owe the lender $50,000. The lender forecloses on the home and sells it at auction. However, after the first mortgage is paid off and fees are covered, only $30,000 is left. It goes to your home equity lender, but you still owe $20,000. This is called a deficiency balance. 

The lender can request a deficiency judgment from the court to cover the remaining balance. If granted, the lender might be able to seize assets (for example, freeze your checking account) or garnish your wages (get a portion of your paychecks until the debt is paid). 

Note: Some states don’t allow deficiency judgments after foreclosures, and others limit how much can be collected. 

What if I’m overwhelmed and unsure what to do about my HELOC?

You don't have to have all the answers! You're learning as you go. These basic tips can serve as a roadmap. 

1. Contact your lender. As soon as you realize there's a problem, reach out to your lender and explain your situation. Let them know you're looking for solutions, like loan modification or forbearance. Be clear that you'd like to avoid defaulting on the loan. (They'd also like that!) 

2. Research refinancing. If your credit score is still good, refinancing the loan to a lower rate could reduce your monthly payments, making it more affordable. 

3. Find out about repayment plans. Your lender may offer structured repayment plans to help you catch up. 

4. Seek out a HUD-approved housing counselor. A HUD-approved counselor specializes in dealing with home debt and can help you explore options to avoid foreclosure. 

5. Sell or rent. One way to deal with the debt is to just get rid of it. Consider selling the property before the foreclosure process begins. If you'd like to hold onto the property, find well-qualified renters to move in and cover the payments, at least until you're back on your feet. 

The most important thing to remember is that you're not on your own. It’s absolutely in your lender's best interest to help you. Plenty of debt relief services exist and offer the tools you need to find your way out. 

This situation isn’t fun, but when it's over, the knowledge you've gained could make you a savvier borrower—and that's a skill you can use for the rest of your life.