Subordinate Loans

HELOC loans, like second mortgages, are subordinate loans. If the property is foreclosed upon or sold at a short sale, the primary lender gets repaid before any other mortgage holder. If there is not enough to pay the amount due on the first mortgage, then the HELOC lender can garnish the borrowers' wages or put liens on their property for up to 20 years to recoup its money.

Recourse

HELOC loans are secured against the equity of the home. However, they are considered recourse loans, which means the lender can go after the borrower for repayment even if the equity and the home itself are gone.

Forgiveness

Your HELOC lender and your primary mortgage holder can agree to negotiate a short sale agreement in which your home is put up for sale, each party shares a percentage of the proceeds and forgives the remainder of the loan. This scenario can save the primary mortgage lender from the potential legal entanglements involved in a foreclosure, and the HELOC lender is likely to get some portion of the money owed.

IRS and Debt Relief

As a result of the Mortgage Forgiveness Debt Relief Act, which was enacted in 2007, you may be able to exclude the forgiven debt having to be declared as income. With a HELOC, however, you need to show records proving you used the proceeds for home improvement.

State Laws Vary

In non-recourse states (Florida and California, for example), once the lender has foreclosed upon a home, the bank can take no further action in pursuing the debt. These laws do not always pertain to HELOC loans, so check your particular state's regulations regarding foreclosures.

Source:

IRS.gov: The Mortgage Forgiveness Debt Relief Act

Realtor.org: Short Sale

More Information:

U.S. Department of Housing and Urban Development: Avoiding Foreclosure