Do You Have to Pay Off Home Equity Loan When Selling House?

When selling a home, any outstanding home equity loan or home equity line of credit (HELOC) must be fully paid off at the time of the sale. This payment typically occurs using the funds generated from the home’s sale. The requirement to settle this debt is a standard part of the real estate transaction process.

Understanding Home Equity Debt

A home equity loan (HEL) provides a lump sum of money, which is then repaid over a fixed period with fixed monthly payments. In contrast, a home equity line of credit (HELOC) functions more like a revolving credit line, allowing homeowners to borrow, repay, and re-borrow funds up to a set limit during a specified draw period.

Both a HEL and a HELOC are considered secured debts because they use the home itself as collateral. This means the lender places a legal claim, known as a lien, on the property title. This lien serves as the lender’s security interest, giving them the right to the property if the borrower defaults on the loan. For a home sale to proceed, all liens attached to the property must be cleared to ensure the buyer receives a clear title.

The Standard Payment Process at Sale

The process of paying off a home equity loan or HELOC during a home sale is typically managed by a neutral third party, such as a title company or closing attorney. Before closing, the title company requests a payoff statement from the home equity lender. This statement details the exact amount needed to fully satisfy the loan, including any outstanding principal, accrued interest, and potential fees, calculated up to the closing date.

At the closing, the sale proceeds are used to cover various costs. The primary mortgage is typically paid off first, followed by the home equity loan or HELOC. The title company disburses the necessary funds directly to the home equity lender from the sale proceeds. Once the home equity debt is fully paid, the lender is obligated to issue a lien release, often called a “satisfaction of mortgage” or “reconveyance,” which formally removes their claim from the property’s title. This document is then recorded with the appropriate county office, clearing the title for the new owner.

Some home equity agreements may include a prepayment penalty or early termination fee if the loan is paid off sooner than a specified period, typically within the first few years. These fees, if applicable, would also be deducted from the sale proceeds.

Addressing Insufficient Sale Proceeds

In some situations, the proceeds from a home sale may not be sufficient to cover all outstanding debts, including the primary mortgage and the home equity loan or HELOC. This can occur if the home’s value has declined since the loans were taken out, resulting in “negative equity” or being “underwater.” If the sale proceeds are insufficient, the seller is generally responsible for bringing additional funds to closing to make up the difference. This ensures the home equity debt is fully satisfied and the lien can be released.

Alternatively, if a homeowner cannot provide the additional funds, a “short sale” might be considered. A short sale is an agreement between the homeowner and the lender where the lender allows the property to be sold for less than the total amount owed on the mortgage and home equity debt. Both the primary mortgage lender and the home equity lender must agree to this arrangement, as it means they will not recover the full loan amount. A short sale can impact the seller’s credit score and may not fully discharge the debt, potentially leaving the homeowner liable for the remaining balance, known as a deficiency.