What Happens to Your Mortgage When You Sell Your Home?

When you’re getting ready to sell your house, one pressing (but not necessarily obvious) question involves your mortgage. What happens to your mortgage when you sell your home?

This guide helps you understand how to calculate your equity and the different scenarios that can arise depending on your equity level.

How mortgages work: A quick overview

A typical mortgage is a lump sum divided over a certain number of years, and that lump sum builds interest as each month passes.

At the beginning of your loan, you pay more toward the interest of your loan than toward the principal (the actual value of the house). As the years pass, a larger portion of your monthly payment is applied toward the principal, and you gain more equity in your home.

When you sell, you must pay off the existing mortgage balance with your home’s equity at closing if your home isn’t paid off entirely.

How to calculate your home’s equity

To calculate equity, you subtract your current mortgage balance from your home’s market value. Homes with positive equity have more value than the mortgage balance, while homes with negative equity have less value than the balance.

It’s most common to have positive equity in your home because real estate prices often increase. As you prepare to sell, you can utilize this equity to pay off your mortgage in a couple of ways. You can:

• Cover the mortgage cost at closing (most typical)
• Apply for a bridge loan that unlocks your equity early so you can buy before you sell

Homeowners in negative equity situations can still sell their homes, but the transaction is a bit different for them. Sellers with negative equity can:

• Bring cash to closing to cover the difference on the balance
• Ask your lender to accept less than what’s owed and pay it off at a later date, also known as a short sale

If you’re unsure about calculating your home’s equity or what your home is worth, it’s best to contact a trusted real estate agent or appraiser who can help you better understand its value.

Steps to pay off your mortgage during a sale

Paying off your mortgage isn’t as simple as handing over a check to the bank. David Gammill, a trial attorney and founder of Gammill Law, puts it this way:

“A mortgage is more than simply a loan; it also gives the lender a lien on your property. Before you can transfer ownership, that lien must be discharged. At closing, the sale money goes straight to the lender to pay off the rest of the loan.”

Without discharging your lien entirely, you can’t transfer ownership to the buyer. Here are a few steps you need to take if you still owe money when you sell.

1. Get your payoff statement

The first task in paying off your mortgage is to contact your lender and request a payoff statement. This statement will include what you still owe on your home, and it’s essential to review it carefully before going to market.

“Most homeowners don’t realize that payback statements from lenders can include mistakes or leave out costs that have already been charged,” says Gammill. “I’ve seen situations when a tiny mistake caused the lien discharge to be delayed.”

2. Estimate your home’s equity

After you receive your payoff statement, you’ll have a better idea of what you need to make in your sale to cover your lien. But before you can calculate your home’s equity, you need a reasonable estimate of your property value.

The most accurate way to determine property value is to consult a realtor for a comparative market analysis (CMA).  This process involves comparing recently sold homes in your market to assess your home’s current value.

Once you know your home’s value, you can subtract the payoff amount on your mortgage statement to understand where your equity stands.

3. Coordinate with a title agent to submit your mortgage payoff

It’s typical for your lender to assign you to a title agent to make the process simple, but you can find your own title company if you prefer.

Your title agent will research your title to ensure there are no issues with it. From there, you’ll share your payoff amount with them and get wiring instructions for your escrow account.

On closing, your title company will work with escrow to wire the funds to your lender to ensure payoff, follow up to confirm the loan is paid, and handle the lien release in the county recorder’s office.

4. Collect the net proceeds after debts and closing fees

After you sign all the required closing documents and the title agent facilitates the mortgage payoff, you can collect your net proceeds.

You will typically receive your funds on the same day or the next business day. However, the process may take longer if there are funding delays or issues with recording the deed.

What happens to your mortgage when you sell your home

When you sell your home, the proceeds from the sale go toward paying off your mortgage.

In most cases, your home’s equity covers the rest of your lien, but things may pan out differently if you have negative equity in your home or if you can transfer your mortgage to someone else.

Here are a few of the scenarios you may run into when paying off your mortgage as you sell your home.

Traditional sale

Homes typically rise in value while you own them, meaning you’ll often start gaining equity from day one. This means that by the time you’re ready to sell, you will be able to cover your whole mortgage at closing.

Mortgages accrue interest over time, and many think you’re responsible for covering all of your interest when you sell. However, you only need to pay the remaining principal balance at closing.

» MORE: See what your house could sell for with a free home value estimate!

Assumable mortgages

Assumable mortgages are specially structured mortgages that are transferable to the next owner.

While these aren’t common through conventional lenders, government-backed mortgages — FHA, VA, and USDA loans — are typically assumable.

Assumable mortgages can be attractive to buyers because they often come with a lower interest rate. This appeal may give you a bargaining chip to negotiate higher prices when you sell.

However, down payments typically cover any costs above the price of your current mortgage balance when assuming the loan, so the structure may limit your buyer pool if you have significant equity and aim to make a substantial profit.

Short sales

Homeowners with negative equity can request lender approval to sell the home for less than the mortgage balance, also known as a short sale.

During a short sale, lenders often agree to take less than what you owe on your home and forgive your outstanding debt, but it isn’t always the case. Depending on your terms, you may still be required to repay your deficient balance.

Short sales also make a significant impact on credit. You can expect a 50-120 point drop in your credit score if you must sell through a short sale.

Are foreclosures and short sales the same?

No, foreclosures and short sales are not the same thing. While both of them typically involve negative equity, the impact on your credit and financial future is significantly different.

Short sales still allow you to sell the home. While you may be underwater with your mortgage and have to sell for a loss, you are still in control of selling your home on the market. This means you:

• Can still live in your home while you find a buyer
• Might take longer to sell your home
• May or may not owe the leftover debt after selling

Banks reclaim ownership when homes are in foreclosure. If you fall too far behind on payments, your lender can enforce the lien on your home.  As a result:

• You will typically need to move out before the sale
• The home is often sold at auction for a loss
• You may go to court over the remaining debt (a deficiency judgment)

Foreclosures also have a much more drastic impact on your overall financial standing. Your credit score will drop significantly, and the foreclosure will stay on your credit report for 7 years.

How do home equity loans and HELOCs affect the selling process?

Second mortgages, such as home equity loans and HELOCs, are also paid off using your sale proceeds. These loans may increase your title fees at the time of sale, reduce your net proceeds, and could be subject to prepayment fees.

And while they may not affect your selling process, you could run into issues or delays if:

• The home sale price won’t cover both your initial and second mortgage
• You don’t disclose your second mortgage or HELOC to your title company
• Your lender doesn’t process the payment for your second mortgage quickly

The most important thing to remember as you prepare to sell is to disclose any liens on your property to your title company. Your title agent can help you navigate the extra work of covering those liens and keep you informed on potential costs.

Should you consider a bridge loan or a buy-before-you-sell option?

If you want to put an offer down on a new home before you sell your old one, you can make the offer with the contingency that your old home sells first. This strategy is common, but it can complicate the process and put pressure on you to sell quickly.

Bridge loans are temporary mortgages that leverage the equity in your old home to make a down payment on a new home. They can make selling easier by:

• Giving you the cash to put a down payment on a new home
• Reducing the pressure to sell your home quickly
• Allowing you to buy your new home before selling your old one

However, using a bridge loan comes with some cons. You’ll carry an additional lien on your home once you sell your first property, and many buy-before-you-sell companies that offer bridge loans charge significant fees to use their services.

Final thoughts: Post-sale considerations

After you sell your home, it’s essential to hold on to all of your paperwork, like the Closing Disclosure and settlement statement, and work with a tax professional during tax season (even if you typically do your taxes on your own).

Consulting with an accountant or licensed tax professional ensures that out-of-the-ordinary tax prep is covered, including:

• Capital gains tax: The tax on the profit of your sale
• Prorated property taxes: Taxes on your property accrued in the year you sold
• Deductions: Some costs associated with selling are tax deductible, including commissions and closing costs

Working with a trusted real estate agent in your area can help the post-sale process go smoothly. A knowledgeable realtor will guide you on the next steps after you sell and can connect you with other professionals in their network.

Need to find a realtor in your area? Clever can help. Try Clever today to match with agents from reputable brokerages like Re/MAX and Keller Williams — all at a 1.5% commission rate.

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