Imagine this scenario: Money is tight and you have both your mortgage and your home equity loan, or second mortgage, to make payments on each month. You know you can only make one of the payments, but you don't want to lose your house. What do you do? In an ideal situation you could negotiate with both lenders to place your mortgages on forbearance and make modified payments to both lenders until you are back on your feet, but if that is not an option, here are the ins and outs of what typically can happen if you can't make your second mortgage payment.
Home Equity Loans and Foreclosure with Equity
If you have been very good about making your payments to both lenders and you have been in your house a significant period of time, you probably gave enough equity built up in your home to cover both the first mortgage and home equity loan. In this situation, you may want to seriously consider selling your house, paying off both mortgages, and walking away with both the profit from the sale and your credit score intact. Because you have enough money built up in your house to cover both loans, your second mortgage lender will not have any scruples about foreclosing if you default on your payments to them.
You second lender is obligated to pay off your mortgage to your first lender if they do foreclose, but because of your hard work paying down your balance there should be plenty of profit from the foreclosure sale for them to pay your first mortgage, cover your debt to them, and potentially come away with a profit. Even though it may be painful to leave your home, it will be far easier to start over with the extra money and a good credit score than to add legal fees to your financial woes and suffer the humiliation and loss of an equity loan foreclosure.
Another solution can be to try to refinance both of your mortgages together, now, before your credit is affected, into a loan where you can afford to make the monthly payments. This solution will only work if you can find a loan that meets your needs. You will usually face a longer repayment term and have to pay fees to refinance, but this may be the best option in your situation.
Home Equity Loans and Foreclosure without Equity
Typically, in a situation where your house doesn't have significant equity built up, a second mortgage lender will be less eager to foreclose on your house. In some cases, but not all, they may even write off the loan because the property's value won't be enough to cover the cost of foreclosing. You may consider, in cases like these, continuing to make payments on your first mortgage, but let your second mortgage payment slide until you are back on your feet. At that point, you will want to get current with your lender as soon as possible. This is definitely not an ideal or even recommended solution, because any mortgage lender always has the right to foreclose on your home if you default on your payments, no matter what the circumstances are, but it is a possibility.
The best possible way to avoid foreclosure from your second mortgage lender is to be prepared. Start saving now to build up a safety cushion should the unexpected happen. Job loss and medical emergencies can throw your entire budget off and put you in a situation that can be extremely painful. Most well informed financial experts will recommend saving at least 2-3 months of your current salary. Another way to avoid home foreclosure from your home equity loan lender is to be very selective about the home loans you accept. Never accept a loan whose payments are more than you can afford to pay monthly. Shop around, ask questions, and don't ever sign paperwork that has any blank spots that can be filled in later. If a lender makes you feel uncomfortable, go with your gut and walk away, even if it's a great deal. By protecting yourself, you can protect your largest investment and your future.