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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.

BSise
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7 Answers7

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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.

JohnFx
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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.

user
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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.

JohnFx
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mpenrow
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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 being so, foreclosure is often not the best option for the debtor - he can get stripped pretty hard in the process.

stannius
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sharptooth
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Refinance the house. You can generally refinance up to 80% of the home's value. That would give you enough money to make payments for quite a while if necessary.

If they are over 62, then they can take out a reverse mortgage to cover the remaining balance and receive payments from the loan to help with living expenses. If they straighten out their income problem then they can start paying off the loan and stop the payments.

rtaft
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Only really stupid people get foreclosed on. Most people who lose the ability to pay a mortgage either refinance for a lower payment that they can afford or sell their house and pay off the debt with the proceeds.

For example, let's say the old couple in your scenario owe $60,000 in principal on a $400,000 house. They list the house at a bargain price: $350,000. The house sells immediately. Normally a bank will be willing to allow mortgage payments to lapse for a couple of months as long as the sale is under agreement. The couple will pay maybe $20,000 in real estate commission plus another $5,000 in fees and interest perhaps. So, they receive altogether $325,000. They pay the bank the $60,000 owed and are left with $265,000 in cash.

Five Bagger
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This is a purely theoretical scenario that basically can't happen in the real world.

And here is why:

After 27 years... the house will likely have appreciated. And the mortgage is mostly worked off...

So we are talking about easily 90+% or 95%+ equity in the place.

Even if something catastrophic happen, what the owners would do is to sell and downsize.

Now can the place be foreclosed on. YES!

Has it happened before? Yes! and with surprising regularity..

But this typically happens to elderly people who are frail and senile...

and it is simply fraud committed against them by dirty bankers... with the help of dirty local officials...

but if everything is happening on the up and up...

the scenario you described SHOULD not happen.

sofa general
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