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I have a dumb question I've been wondering about. It doesn't apply to me; it's just theoretical.

Suppose there's an older couple who bought a house 27 years ago. They have faithfully made the payments on their mortgage, and currently their equity is 92%. Suddenly, the husband loses his job, and they can't make their mortgage payments. So the foreclosure process begins.

Am I correct that, if the foreclosure process is taken to conclusion and the couple loses their home, they will lose all of that 92% equity they built up? In other words, they will be treated the same as a young couple who currently has 4% equity in their home?

If that's true, then basically that means that a homeowner's risk increases as their equity increases. Which seems kind of perverse.

But maybe I am totally overlooking something; I don't have much experience with home ownership and have no experience with foreclosures.

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I think that in this case the smartest thing to do would be getting a HELOC and paying the remaining mortgage with it. Then repay HELOC ASAP, but with interest-only minimum payment it might be easier to bridge the rough times until a new job is found. – littleadv Dec 6 '11 at 0:33
@littleadv - this should be an answer, not comment. It's the right solution for this type of situation, although the OP needs to be aware, a house can be foreclosed on for back taxes (real estate) as well, not just for mortgage debt. – JoeTaxpayer Dec 6 '11 at 1:19
I don't know about foreclosure law, but I figure the scare of losing equity gives a person greater incentive to solve the problem, perhaps by selling the underlying asset before it becomes a court sale... – jldugger Dec 6 '11 at 1:43
I don't understand why they would let it get that far. Why not sell the house (at a current market value that should significantly exceed what was paid 27 years ago, and easily cover the remaining 8%), use some of the proceeds to pay of the outstanding amount, and then put the rest towards a new house? – aroth Dec 6 '11 at 5:26
@aroth - Because people think that it will be easier to just let the bank sell their home for them assuming the bank will at least try to get a decent price. Occasionally the person will be in jail and unable to do anything with their home. And sometimes it happens when an elderly person who lives alone and has no one to take care of their affairs has an extended stay in the hospital or ends up in a nursing home. There are social workers to handle the affairs of the destitute but few places have it in place for those who are not. – user4127 Dec 6 '11 at 16:49

This article provides a good summary of the ins and outs of it: What happens to Equity during a foreclosure.

The short version is that you are entitled to the proceeds of a house sold in foreclosure minus any outstanding balance on the loan, fees, and any other costs the lender incurs during the process. Do understand that foreclosure houses tend to sell at an extreme discount, so the potential for losing a large chunk of equity is very high in that situation.

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Practially if the house is bought 27 years ago, it would have appreciated quite a bit. Definately 4 to 5 times the original value. Hence the owners would not only get 92% but my guess would be they would get much more in actual $$ – Dheer Dec 6 '11 at 6:20
@Dheer. 4 to 5 times in 27 years? I've clearly been dealing with the wrong states here in the US. 2 times, sure. – gef05 Dec 6 '11 at 14:03
And sadly since there is no incentive to sell the house for value seeing as the bank only needs to get ~8% these houses tend to go for less than homes where they bank is entitled to 50%+. Many states do not require that the homes be made available for auction and often private deals happen before they go to the market. My wife did title work for foreclosure sales and told me about these occasionally. – user4127 Dec 6 '11 at 16:45

According to wikipedia

Foreclosure by judicial sale, more commonly known as judicial foreclosure, which is available in every state (and required in many), involves the sale of the mortgaged property under the supervision of a court, with the proceeds going first to satisfy the mortgage; then other lien holders; and, finally, the mortgagor/borrower if any proceeds are left.

So the couple in your example would get some of that 92% equity back. Minus legal fees and depending on what the property sold for.

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If the couple has been making their payments diligently for 27 years, first off I think the bank would be willing to negotiate. A foreclosure is not a good solution for anyone.

Also, keep in mind that you are talking about 8% of the original loan amount. Let's say the house went for $150,000 (nominal) when the couple bought it 27 years ago. That'd probably be on the high side, and of course the current market value of the house is irrelevant for this calculation. It would leave them with a $12,000 debt load at present. Even a reasonably high-interest (but not credit card) loan for that amount is most certainly bearable in terms of interest costs even on a limited income; a 10% interest rate would incur a cost of $100/month before tax effects. A payment plan to pay that loan off in five years brings the initial grand total up to the neighborhood of $300/month.

As has been pointed out, the bank can only take what is owed to them, but of course if the only additional equity the couple can provide is locked up in the house, selling the house is going to become necessary to enable access to that equity. In some jurisdictions (I don't know about the US, but Sweden has such provisions), debt collection is specifically called out to be made in as non-invasive a way as possible. Yes, the bank can force a foreclosure on the house, or for that matter any other asset which is collateral for a loan, but if there are other assets which can be used to cover the debt and will be less invasive to the couple's life, those are taken first. And it's rare that one has no assets other than the house, particularly at age 50+.

If the bank still demands payment in full to avoid foreclosure, especially with such a relatively small amount outstanding, it might not be unreasonable to ask around for a personal loan from family or friends. Use it to pay off the loan to the bank (or even maintain payments), then pay it back to whoever loaned them the money as quickly as possible.

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In the US, bank can only take the collateral used to secure the loan, nothing else. If the house is mortgaged and they default - the house is taken, not the jet they have parked in the nearest airport, or the yacht at the marina. – littleadv Jan 11 '13 at 8:13
@littleadv Strictly speaking, I don't even see the question specifying a jurisdiction. :) And the couple could conceivably sell things themselves to raise cash. – Michael Kjörling Jan 11 '13 at 9:40
Not disagreeing with you, just pointing out the differences;) – littleadv Jan 11 '13 at 10:30

The house will be sold and the bank will be the first entity to demand all possible fees. So the debtor will still get most of the equity. There're two major catches though.

First, missing payments often incurs huge fines and fees and those might be bigger that you can expect and of course they can be larger than what the debtor was owing to the foreclosure moment. All those fees and fines will be demanded from the debtor.

Second, the lender is not interested in selling at the best price - remember, they only want their money back, they don't care of the debtor equity. So the bank will often sell cheap and this can greatly reduce what the debtor has in the end.

That said, foreclosure is often not the best option for the debtor - he can get stripped pretty hard in the process.

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I think that "the buyer" is in fact "the owner" in this case. Otherwise your response is a bit confusing... – littleadv Dec 6 '11 at 6:42
@littleadv: You're right, I changed to debtor. – sharptooth Dec 6 '11 at 6:53

Basically the technical answer is "Yes." If a person stops making all payments, does nothing about the foreclosure notice then yes the bank can come and take the property including the 92% equity position.

The reality, however, is that would be very, very unlikely. A couple that close to paying off a mortgage is going to be close to retirement. Rather than lose their house, they could break into their retirement account, pay the penalties, and put it toward the mortgage.

A family member could bail them out. They could get a reverse mortgage. They could qualify for one of the US Treasury Home Affordable Foreclosure Alternatives program, which is part of the Obama Administration’s Making Homes Affordable program. the book...the bank could take all.

You can read more about how to avoid foreclosure in my recent blog article "Avoid Another Foreclosure Crisis – Take Matters Into Your Own Hands."

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This is actually wrong. A bank cannot take more than the amount they are owed - i.e. 8% of the mortgaged value. – DJClayworth Jan 10 '13 at 20:42
"A couple that close to paying off a mortgage is going to be close to retirement." Aside from @DJClayworth's point, this is not necessarily true. Depending on how aggressively the hypothetical couple has been paying down debt, it's certainly possible to be close to paying off a mortgage without being close to retirement. Of course, if they have been living in the house for 27 years, they probably are fairly close to retirement, but that's a completely separate question. – Michael Kjörling Jan 10 '13 at 22:15
DJClayworth, while it is true that a bank cannot take more money than the amount they are owed, more often than not, the bank is the only bidder at a sheriff sale. If no one bids against them, then they get the house for 8% of the mortgaged value. – Simon Campbell Jan 15 '13 at 0:54

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