What Happens to Equity in a Foreclosure? A Guide

Foreclosure can leave many homeowners feeling lost, confused, and with countless unanswered questions. What’s next? How do I move on? And What happens to equity in a foreclosure? 

We are here to tell you that foreclosure is not the end, and that there’s a way forward. Whether you’re facing foreclosure or simply want to be prepared should you find yourself in this situation, read on as we discuss what happens to home equity in the event of a foreclosure –– and how you can work to protect your investment. 

What Is Home Equity? 

Home equity is calculated by subtracting your mortgage balance from the current market value of your home. The resulting figure, your home equity, is the portion of your home that you own outright. This equity is a valuable asset –– one that can be leveraged for countless financial needs like loans, renovations, or even retirement funds. It’s also an indicator that your initial real estate investment has grown. As, with every mortgage payment and uptick in the market, your share of equity increases. 

For these reasons, the accrual of home equity is often a primary financial goal for some homeowners. This accumulated equity can offer some excess funds during times of need or be wielded as a strategic asset for other investments. It can also provide you with peace of mind that comes from having a valuable asset capable of supporting your future endeavors. Whether you plan to use this equity for home improvement projects, as a retirement nest egg, or spin it into the purchase of another property, protecting your home equity can be a top concern. 

How Foreclosure Impacts Your Home Equity

While most homeowners hope to make on-time mortgage payments and grow their home equity, certain unforeseen circumstances can get in the way. Some face health crises, fall behind on payments, or lose jobs. This was the case during the 2008 Housing Crisis, when an economic downturn caused a record number of American borrowers to default on their mortgages –– sending over three million properties into foreclosure in a single year.¹ 

In a foreclosure, a mortgage lender takes legal action to recover a loan’s balance from a borrower who is no longer making mortgage payments. When a foreclosure takes place, the lender’s primary goal is to sell the property as quickly as possible to repay the remaining mortgage debt. This means foreclosed homes are typically sold at below market value, which can significantly impact your home equity, resulting in what is known as equity loss. 

When a lender is forced to foreclose on a home, it’s likely because there are months of unmade mortgage payments and penalties that have begun piling up. In the event that a foreclosed home sells for more than is owed on it, these penalties and fees are subtracted from the home equity. For example, if a homeowner has $200,000 in home equity on a property they purchased for $300,000 and the home sells for $250,000, a lender recoups the balance owed and $150,000 worth of equity remains. But after penalties and fees, enough equity loss may occur that a homeowner only walks away with very little (if any) of their equity.² 

How Equity Loss Happens

Just like there are many different reasons for foreclosure, equity loss can happen in many different ways. Some primary factors contributing to equity loss include: 

• Unpaid Mortgage Balances: Foreclosure doesn’t happen overnight. Rather, it’s the result of several months of nonpayment. So when foreclosure takes effect, many homeowners have thousands of dollars in unpaid bills that a lender will also seek to collect. And the larger this balance is, the more it will eat into any home equity there is left. The same is true if you have taken out a second mortgage or home equity loans, which further reduce the amount of equity you will hold in your home after foreclosure.
• Market Conditions: Home equity is accrued through monthly payments and increasing property value. By the same token, if property values have decreased since you purchased your home, your equity may be further diminished. Depending on market conditions, a dramatically lower sale price may mean you end up with negative equity –– walking away from foreclosure with no equity at all. 
• Legal and Administrative Fees: Like the sale process, which includes thousands of dollars of closing fees, the foreclosure process involves various fees that can further deplete your equity. Attorney fees, court costs, and real estate agent commissions all contribute to the depletion of your equity and make it challenging to net a financial benefit from the sale of your home.

Repercussions of Equity Loss

Losing equity in a foreclosure can mean losing years of hard work and financial progress, but it can also have other long-term financial (and emotional) repercussions. 

One of the biggest repercussions of foreclosure and equity loss is the impact on your credit score. This impact is immediate, significant, and lasting –– as a foreclosure can reduce your credit score by several hundred points, making it challenging to obtain new lines of credit or loans (including a mortgage) in the future. This mark on your credit report can remain for up to seven years, negatively impacting your ability to buy a new home, secure favorable loan terms, or even get hired in certain industries. 

The loss of home equity that can come with foreclosure can rattle your financial foundation. For many homeowners, equity can account for a substantial portion of their net worth. Without the safety net that this equity provides, it can be more challenging to weather economic hardships, save for retirement, or accomplish short- and long-term financial goals. 

Perhaps the biggest impact, however, is one that few people discuss: the emotional toll that foreclosure and equity loss can have on homeowners. This process can bring with it deep, complicated feelings. Loss, grief, anxiety, and shame. And while it is normal and healthy to feel these emotions during and after foreclosure, it’s important not to dwell on this moment –– but to learn from it. Foreclosure is a speed bump, not the end of the road. The best thing you can do when faced with this challenge is keep your head up and keep moving forward. In addition to processing your emotions in a healthy way, protecting your existing equity can help you pick up the pieces and turn the page. 

Protecting Your Investment: Preventing Equity Loss 

Once foreclosure has taken effect, there’s little homeowners can do to prevent equity loss. But there are several measures that can be taken beforehand to preserve part of the investment.

Loan Modification

Foreclosure takes effect after 120 days of nonpayment, meaning there’s plenty of time to reevaluate the terms of your mortgage before foreclosure is the only remaining option. If you’re unable to make your mortgage payments, you may be able to work with your lender to modify your loan –– reducing your monthly payments and the interest rate by extending the loan’s overall duration. 

Loan modifications are by no means guaranteed, and the new loan terms may mandate that you miss no further payments, but this strategy can provide the breathing room you need to regain financial stability and figure out how to prevent foreclosure, protecting your home and your home equity.³

Short Sale

We noted earlier that foreclosure can be harmful to home equity, but it can also do lasting damage to a borrower’s credit. A short sale is an alternative to foreclosure in which the lender allows a homeowner to sell their home for less than they owe on the mortgage. While this results in selling the property at a lower value –– and virtually guarantees equity loss –– it can prevent the more lasting credit score consequences of foreclosure.⁴

Deed in Lieu of Foreclosure 

When a borrower has explored all other options and accepted that losing their home is in the cards, they can voluntarily transfer ownership of the property to a lender via a deed in lieu agreement. This strategy releases the borrower from mortgage obligations, meaning they won’t have to make any further monthly payments. A deed in lieu of foreclosure will still be harmful to a borrower’s credit profile but will not linger for the mandatory seven years as with a foreclosure.⁵

Understanding Your Rights 

Per their mortgage agreements, lenders have the right to seize control of a property if a borrower fails to hold up their end of the deal. But homeowners have rights of their own. During the foreclosure process, homeowners’ legal protections include: 

• Right to Reinstate: Depending on your location, you may have the right to reinstate your mortgage prior to foreclosure. A right to reinstate clause allows homeowners to catch up on any missed payments with a single lump sum payment, thus restoring the mortgage to its original terms before the foreclosure sale. While this right can be exercised up until a few days prior to the sale, it’s best to exercise your right as soon as possible to protect your equity.
• Right of Redemption: Homeowners also have the right to reclaim their properties by paying the full sale price before –– and in some states, after –– the foreclosure. The right of redemption permits borrowers to pay the full foreclosure sale price and keep their homes. However, given the funds required to purchase the home, few buyers exercise this right. Learn more about how to delay eviction after foreclosure.
• Equity Distribution: As mentioned above, there may be instances where a foreclosure yields more than you owe. In some cases, this may mean equity remains after all legal, administrative, and past-due fees have been paid. You are entitled to this remaining equity –– and it’s important to understand this right should you endure the foreclosure process. 

Equity Loss in Judicial vs. Non-Judicial Foreclosure Processes 

There are two general types of foreclosure, decided by the lender: judicial and non-judicial. Each process is unique and will affect home equity in different ways. 

Judicial Foreclosure

As the name might suggest, a judicial foreclosure is a foreclosure decided before a court. A lender and borrower will each bring forth evidence, which can be a lengthy process—sometimes delaying a foreclosure for a year or more. This extended timeline allows homeowners to explore alternatives (like loan modifications or short sales) that can help preserve equity. However, the hefty legal fees and court costs associated with judicial foreclosures can dramatically reduce the amount of equity left over from a foreclosure sale.

Non-Judicial Foreclosure

Alternatively, non-judicial foreclosures bypass the court system, instead allowing lenders to foreclose on properties on a shorter timeline and with fewer expenses. Non-judicial foreclosures come with the benefit of being faster and less costly –– potentially preserving home equity that would otherwise be spent on legal fees –– but they offer homeowners limited chances to dispute the foreclosure or negotiate more favorable terms.⁶

The processes for both judicial and non-judicial foreclosures can differ greatly from state to state. If you find yourself in this situation, consult with a legal professional to understand your specific circumstances. 

Tips for Preserving Equity

Avoiding foreclosure is one of the best ways to preserve your equity, and this goal can be accomplished in a number of ways. If you’re struggling to pay your mortgage and worry that foreclosure may be on the horizon, consider these alternatives.

1. Refinancing: When you refinance your mortgage, you effectively replace your existing loan with a new one –– only with different terms. In some cases, this can help you lower your monthly payment by securing a reduced interest rate (or stretching out your loan term.) For homeowners struggling to meet their current mortgage obligations, refinancing your home equity loan can be a lifeline, providing the relief needed to prevent foreclosure and preserve home equity. There are certain criteria you must meet in order to refinance, including a strong credit score and sufficient home equity. But if you meet these qualifications, refinancing could be your best bet in avoiding foreclosure.

2. Consult a Financial Advisor: No one should go through rocky times alone. Navigating the foreclosure process while protecting your equity can be complex, and the answers you’re looking for might require the support of a professional. Financial advisors can help you fully understand your options, negotiate terms and alternative paths with lenders, and develop a comprehensive plan to safeguard your equity. They can also provide guidance tailored to your unique financial situation, helping you make more informed decisions and protect your investment.

3. Truehold’s Sale-Leaseback: Sometimes, your best bet is to take control of your home equity before you lose control of your home. Truehold’s sale-leaseback allows you to do exactly that. When you sell your home to Truehold, you receive your hard-earned home equity –– no strings attached. Then, rather than leaving your cherished home, you can continue living at the same address as a renter. Even more important, you can pay off debts with your home equity. You can take your time to shop for a home that better fits your situation. And you can begin writing the next chapter of your life, on your own terms. Rather than lose your equity to foreclosure, you can use it. For whatever comes next. 

The Final Word from Truehold

Foreclosure is one of the most difficult situations any homeowner could find themselves in. But with the right preparation, and with a clear understanding of what happens to your equity during foreclosure, you can navigate the process with poise –– while protecting your most valuable asset. At Truehold, we’re committed to empowering homeowners by equipping them with their home equity. To learn more about our sale-leaseback and the difference it can make when faced with foreclosure, connect with one of our empathetic advisors today. 

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Sources:

1. CNN. Foreclosures up a record 81% in 2008. https://money.cnn.com/2009/01/15/real_estate/millions_in_foreclosure/‍
2. Experian. What Happens to Your Equity in Foreclosure? https://www.experian.com/blogs/ask-experian/do-you-lose-your-home-equity-in-foreclosure
3. ‍Amourgis & Associates. Using a Loan Modification to Avoid Foreclosure. https://www.amourgis.com/blog/using-loan-modification-to-avoid-foreclosure/ 
4. Rocket Mortgage. Short Sale Vs. Foreclosure: Which Is Better for Buyers? https://www.rocketmortgage.com/learn/short-sale-vs-foreclosure 
5. Investopedia. Deed in Lieu of Foreclosure: Meaning and FAQs. https://www.investopedia.com/terms/d/deed_in_lieu_of_foreclosure.asp 
6. Justia. Judicial vs. Non-Judicial Foreclosure Under the Law. https://www.justia.com/foreclosure/judicial-vs-non-judicial-foreclosure/