HELOCs and Foreclosure

The Basics

LAF

What is a HELOC?

•  Home equity line of credit

•  Revolving credit that is

secured by the borrower’s

property.

•  Lender allows the borrower

to draw from the funds

whenever he chooses.

•  High limits with low-interest

rates.

HELOC

•  Line of credit

•  Repayment period and/or

balloon payment

•  Possibly interest only

payments, or negative

amortization

•  Lower up front costs

•  Flexibility of funds available

•  Promissory note

Home Equity Loan

•  Fixed amount

•  Fixed interest rate

•  Fully amortized

•  Higher up front

costs

•  Promissory note

Subordinance and Recourse

•  Normally Subordinate to primary home loans. This

means that the HELOC lender has claim to any money

generated by a foreclosure, only after the primary

mortgage lender recoups their full loss.

•  Almost all HELOCs are considered “recourse loans.”

The borrower is personally responsible for paying

recourse loans in full, regardless of their property’s

value. If the lender doesn’t recoup the full cost of the

HELOC during foreclosure, they can sue the borrower

for the remaining money owed.

Draw Period

•  Span of 5-10 years during which the borrower

can withdraw money whenever he chooses.

•  Borrower will be given a checkbook or a special

credit card to use for withdrawals.

•  Like a credit card, when money is taken out, the

borrower will receive a monthly bill and must

make a minimum payment (sometimes interest-

only). When no money is withdrawn, the

borrower will not be charged.

Reset

•  Many HELOCS have the option for a

lower payment term for the first ten to

twenty years.

•  Reset, in most instances to fully

amortizing loans.

•  Usual result is a substantial increase in

the monthly payment amount.

•  Reset is based upon the terms of the

original contractual agreement for the

HELOC.

Repayment period

•  Period after reset is called the repayment

period

•  During the 10-20 year “repayment period” the

borrower cannot make any more withdrawals

from the line.

•  To determine the monthly bill, the total

amount withdrawn is divided by months

allotted for the repayment phase.

HELOC Freeze

•  Lenders reserve the

right to reduce the

credit line should the

home value decline.

Short Sale and Foreclosure

•  Deed in lieu of foreclosure

•  Straight-Up Short Sale

•  Short Sale with Incentive to HELOC Lender

•  Primary Lender Forces Foreclosure

•  HELOC Lender Forces Foreclosure

•  HELOC Lender purchases first mortgage and

forecloses

Deed in Lieu of Foreclosure

•  Lender agrees to accept a deed to the property instead of

foreclosing in order to obtain title.

•  Deficiency amount is the difference between the fair market

value of the property and the total debt

•  In Illinois, a lender may not obtain a deficiency judgment

following a deed in lieu of foreclosure unless the borrower

agrees to remain liable by signing such an agreement at the

same time as the deed in lieu of foreclosure

Straight-Up Short Sale

•  Primary lender and the HELOC lender must

agree.

•  As a part of the short sale agreement, borrower

may be required to pay a certain amount to both

lenders in order for account to be considered

closed. This may be addition to the money

recouped by the sale.

•  Credit report will note that the account was

settled but that the full amount was not paid.

•  May still result in deficiency unless agreement

indicates otherwise.

Short Sale with Incentive to HELOC

Lender

•  It can be difficult to get a HELOC lender to

agree to a short sale;

•  If the primary lender wants to push a short

sale, it may offer the HELOC lender an

incentive to sign off on the sale.

•  May still result in deficiency.

Primary Lender Forces Foreclosure

•  If property is foreclosed upon, primary lender will

be paid everything it is owed with the money it

takes from the sale.

•  Since the HELOC loan is subordinate to the first

mortgage, the HELOC lender will be paid with

any remaining money.

•  If the HELOC lender is not paid the full amount

owed on the line, the HELOC becomes an

unsecured debt and the HELOC lender can

pursue judgment.

HELOC Lender Forces Foreclosure

•  Some borrowers stop paying their HELOC

while continuing to pay their primary

mortgage. In this case, the HELOC lender may

decide to force foreclosure.

•  Primary mortgage lender may receive the

lion’s share of the foreclosure money.

•  Unless there is a lot of equity in the home,

HELOC lenders often choose to wait it out

rather than forcing foreclosure themselves.

HELOC Lender Purchases Primary

Loan

•  If borrower stops paying HELOC while still

making primary mortgage payments, the

HELOC lender may try to purchase first

mortgage in order to initiate foreclosure

proceedings.

•  As the holder of both the first and second

loans, the lender will be able to recoup the

maximum amount possible.

If borrower cannot afford second mortgage and

wants to save the home - options:

1. Refinance with lender

2. Shop for a new HELOC.

3. Get a new first mortgage and payoff HELOC.

4. Look into modification

HELOC Modifications

•  2 government programs for second mortgages

– 2MP and FHA2LP

•  Proprietary Modifications

•  Illinois Hardest Hit

Second Lien Modification Program

(2MP)

•  First mortgage was permanently modified under HAMP and

second mortgage is on the same property, borrower may

be eligible for a modification or principal reduction on the

second mortgage as well, through MHA’s Second Lien

Modification Program (2MP). ONLY AFTER

MODIFICATION OF FIRST MORTGAGE

•  Resources for 2MP

https://www.makinghomeaffordable.gov/steps/pages/step-2-

program-2mp.aspx

and

https://www.hmpadmin.com/portal/programs/

second_lien.jsp

FHA Second Lien Program (FHA2LP)

•  If first mortgage servicer agrees to participate in FHA Short Refinance,

borrower may be eligible to have second mortgage on the same home

reduced or eliminated through the FHA Second Lien Program (FHA2LP).

•  Must be negative equity and also only for borrowers that are current on

mortgage.

•  All servicers of eligible second lien Non-GSE Mortgages may participate in

FHA2LP. A servicer need not service the related first lien or participate in

HAMP in order to participate in FHA2LP.

•  Refinance into an FHA-insured loan where the unpaid principal balance

(UPB) of the original first lien mortgage is written down by at least 10

percent and the amount of all mortgage debt, after the FHA refinance,

does not exceed 115 percent of the current value of the property. Lender

will be required to reduce the amount owed on first mortgage to no more

than 97.75% of your home’s current value.

•  ONLY AFTER MODIFICATION OF FIRST MORTGAGE.

•  Resources: https://www.hmpadmin.com/portal/programs/fha2lp.jsp

Other modifications

•  Proprietary modifications – Some lenders

offer proprietary modifications of second

mortgages without modification of first

mortgage. The terms of those modifications

are set by the lender but may be HAMP-like.

Example, Bank of America.

•  Illinois Hardest Hit may also be applicable.

Bankruptcy

•  If there is no equity in home, a Ch. 13 bankruptcy

(reorganization bankruptcy) is a possibility to “strip off” the

HELOC.

•  A bankruptcy attorney must be consulted.

HELOCS can be sold to debt

collectors

•  If payment is not made, the loan may go into

default and be sold to a collection company to

recover. Home equity lenders and second

mortgage holders frequently choose to pursue a

standard lawsuit to obtain a money judgment

rather than proceeding with foreclosure action.

•  If the creditor does not foreclose, rather sues and

obtains a judgment, the creditor may be able to

garnish wages, levy bank accounts, or attempt to

seize other property.

Questions?

If you have any questions about, HELOCS

and foreclosure, or the materials – please

contact amargalit@lafchicago.org