A home equity loan is a secondary loan secured by the value of a home (the difference between the loan balance and the current market value of a property). The home equity loan is often considered a junior lien and is in second position to the mortgage holder, which is known as the primary lien. In a foreclosure, specific rules apply to the handling of a home equity loan.
A home equity loan is a tool that many homeowners use to cash out the value of their property. Home equity loans are most commonly utilized for paying for expensive home remodeling projects or the cost of college tuition. This type of loan is a way for the homeowner to use the equity that has built up over time as a line of credit to help with major life expenditures.
A lien on a property is a legal interest that another party other than the homeowner has in the home. The first mortgage lien is filed upon origination of the mortgage loan and is always considered the primary lien on a property. This means that in a foreclosure sale, what's owed to the primary lender is the first priority when it comes to repayment.
A home equity loan is something that a homeowner cannot be approved for until he has at least 20 percent equity in his home. Since the opening and filing date of this lien is much further in the future than the primary loan, it is in second position for payment in a foreclosure sale.
When a homeowner becomes delinquent on her payments, the primary mortgage holder is usually the party who files for foreclosure proceedings. Once a loan is in default -- 30 or more days past due -- the foreclosure process can begin. It's at this point that the parties from the primary mortgage company and the home equity loan lender can begin to negotiate a settlement for the home equity loan so that the secondary lienholder doesn't have to write off the entire amount of the loan as bad debt. It is important to note that the primary lienholder -- the first mortgage company -- is not under any obligation to provide the secondary lienholder with a settlement, yet if the primary and secondary liens are with the same bank, settlements for proceeds of the property are disbursed between the two loans.
If the home equity lienholder files for foreclosure proceedings, it still doesn't change the payment order. If the auction or post-foreclosure sale of a home doesn't net enough money to pay the balance of the primary loan, the secondary lienholder receives no proceeds.
Once a foreclosed home has either been auctioned off or sold after the foreclosure auction by a real estate brokerage, the primary mortgage holder receives its proceeds. Any overage amount over the loan balance, late fees and attorney fees are payable to the secondary mortgage holder.
If there are no proceeds left over from a foreclosure sale, or if the sale amount was not adequate to pay off the primary mortgage, the home equity lienholder isn't without options. A home equity lienholder can file a judgment against the borrower. This judgment will remain on the borrower's credit for up to 10 years if unpaid and can cause major difficulties should the borrower want to make a large purchase in the future.
It's not uncommon for some borrowers to file either a Chapter 7 or Chapter 13 bankruptcy. While this will offer temporary protection against foreclosure from the primary lienholder, this can be bad news for the home equity loan lienholder. During a bankruptcy hearing, most debts are discharged and are ordered to be written off or settled for a lesser amount with a creditor. In the case of pending foreclosure, a home equity loan is considered an unsecured debt and the secondary lienholder will typically walk away with nothing.