Your Down Payment Disappears During Foreclosure

Many homes that are now going into foreclosure were purchased with no money down and, therefore, have no equity when the lender begins the foreclosure process. Other home buyers, though, put down large amounts to receive lower interest rates and build up the equity in their homes. However, they are now facing foreclosure due to a financial setback. When the home goes through foreclosure, the down payment will often be eaten away by accelerated interest, court costs, attorneys fees, and late fees; although having the extra equity may also help homeowners stop foreclosure before the situation is too far gone.

When properties go into foreclosure, the acceleration clause in the mortgage paperwork allows lenders to begin adding interest and fees in order to increase the total amount necessary to reinstate the loan or pay it off in full. This is to provide the bank with some of the lost profits that will result from the foreclosure, as opposed to having the loan paid off in full throughout the life of the mortgage, or paid off through a refinance or sale of the property. Banks also want as high of a payoff as possible, in case the property sells for a substantial amount at the sheriff sale, where they can take the largest portion of the sale proceeds. Homeowners typically see their mortgage balance grow by several tens of thousands of dollars during foreclosure, as the bank adds in numerous legitimate and junk fees.

These fees are primarily responsible for the complete lack of equity in the property by the time of the sheriff sale. Even homeowners who put down 10%, 20%, or more will find that this money has simply been eaten up by interest added to interest added to late fees and court costs. It is also not uncommon for homeowners to owe more on the home than it is worth. This situation ensures that the bank will receive all of the proceeds of the sheriff sale, even while taking a loss on the total amount that they are owed through the foreclosure judgment. Also, foreclosure victims who are upside-down in their homes will find it very difficult to put together a plan to stop foreclosure, as they have no equity.

This makes it a very serious decision for homeowners to make when considering how much of a down payment to make. Obviously, a higher down payment allows for more protection of the home with higher equity, and often results in a lower interest rate for the term of the loan. However, if the homeowners do not have access to more liquid assets, such as an emergency fund in a bank account, a temporary financial setback can push them into foreclosure, where their equity will quickly disappear. Having both as much equity as possible and a reasonable emergency fund will provide homeowners with the best deal on their mortgage and the best insurance to contain the damage of an unforeseen hardship.

No matter how high a down payment a home purchaser makes at the time the mortgage is signed, there is no easy way to access this equity in the event of a financial hardship. Lenders will be reluctant to provide a loan to stop foreclosure, and the acceleration of the mortgage will continue to eat up the homeowners' down payment and remaining equity. This is why a large down payment is only a good idea in conjunction with easily accessible funds that can quickly be converted to cash. Without an emergency fund and with the erosion of equity due to the foreclosure, homeowners will quickly run out of options that could have saved their homes from foreclosure.