What Happens to Home Equity during a Foreclosure?

During a foreclosure, you may be able to protect some of the equity you have built in your home, but how the equity is distributed is subject to a variety of factors. You should understand the motivation of the lender as well as the rules that it must follow. Ultimately, while you may realize some level of cash payout if all goes well, in most cases much of the equity is lost during the process.

What the Lender Wants

When a mortgage reaches foreclosure, the lender’s sole motivation is to recoup the outstanding loan balance as quickly as possible. The longer the liability must be carried on its books, the worse for the lender from a balance sheet perspective. The lender is entitled to recoup the outstanding loan balance, as well as some of the fees associated with reaching this end, but any profit realized by the sale of the property typically belongs to the homeowner. It is important to check the laws of your given state or municipality as the specifics may differ from state to state and county to county.

The health of a financial institution’s balance sheet is directly related to how it is perceived and to factors that affects how it can function in the market. Lenders will usually push to sell quickly in an attempt to defend their balance sheet. It is important to monitor the process to protect your interests.

The Procedure

Typically in the case of a foreclosure, the property is first taken over by the lender and listed for sale. This offer price is often determined by law and is at, or near, fair market value. The price may then be dropped as the property is offered for short sale. Ultimately, after a statutorily determined waiting period, the lender may cause the property to be sold in an auction, with the highest bid taking the property, no matter the amount below fair market.

The speed at which the lender may proceed is directly affected by how much it needs to sell the property for to cover the principal balance. Your interests as the homeowner are directly at odds with the lender’s because you want the bank to push for a higher sale price and protect your equity. When there is little equity in the property, the lender may shop the house more patiently, trying to recoup a more significant portion of the loan. In cases where there is significant equity, the loan balance is low. In this case, the lender usually tries to move through the steps quickly.

Protecting Your Equity

At the point that your home has been foreclosed, you can still take steps to protect your equity. Researching and knowing the specific rules for your area will help you to ensure that the bank does everything required. For example, a lender must make reasonable effort to advertise the house; if you are monitoring this, it is more likely to be done properly. Furthermore, you can ensure that the required periods are met and during the whole process can aid in the sale to maximize the capital that will be returned upon completion of the sale.