Secured Debt Vs. Unsecured Debt in Foreclosure

Debt types

There are two types of debt: secured and unsecured. The difference between the two is that a secured debt has some kind of collateral that could be repossessed by the lender should the borrower default on the loan. A good example of secured debt would be a mortgage or a car loan. Unsecured debt, on the other hand, is debt that has no collateral attached to it, like a credit card or personal loan. When it comes to foreclosure, both secured and unsecured debt can come into play.

Primary Mortgage

The mortgage on a property is secured by a lien filed by the bank the day that the loan was originated, and the house acts as collateral. The lien is an ownership interest in the property that allows the lender rights to be paid in full in the event of a sale on the property, at a foreclosure auction or in a post-foreclosure sale. This lien takes first priority when it comes to a payoff, even though other parties can file a lien against a property for different types of debt.

Secondary Mortgage

If a homeowner takes out a home equity loan or line of credit, this debt is also secured using the house as collateral. Since this type of loan is originated based on the amount of equity the borrower has in the property, the secondary mortgage is the second and only other secured debt, or lien, on the property.

Types of Liens

The primary mortgage is always the first lien on a property. Any second mortgage is also secured by the house as collateral. However, other types of liens can be attached to a property as well. For instance, a contractor who goes unpaid can file a mechanics lien, if the borrower has any unpaid federal or state income tax a lien can be filed, if the borrower has any unsecured debt such as a credit card or personal loan a lien can be placed on the property. The priority of such liens, however, varies greatly.

Lien Priority

Any entity that has a lien on a property also has the right to foreclose on the property, using the proceeds of the sale as collateral. Smaller, unsecured debts will usually lose out on payment in full in the event of foreclosure, as any proceeds of the sale are first given directly to the primary mortgage company, then any second mortgage. Anything in addition to these proceeds is doled out based on lien property.

The lien priorities are as follows: unpaid child support, mechanics liens, then any delinquent federal or state income taxes, then to a home owner's association and finally to unsecured debt holders. In many situations of foreclosure, the unsecured liens will leave the sale with empty pockets.

It is because of this that few unsecured debt liens will proceed with a foreclosure. The purpose of a lien on a property in this case is to secure payment when the property is sold via a traditional venue, not a foreclosure sale. A clear deed cannot be conveyed to a new buyer unless the lien is settled out of any seller proceeds. At this point, the unsecured debt holder ensures payment.

Foreclosure

If any entity is going to take the steps to foreclosure, it is normally the primary mortgage holder. Unless property values are very high, based on market values, the second mortgage holder is highly unlikely to be the first to file a foreclosure. If values are high, there is a better chance for proceeds over and above what is owed to the primary lender.

The reasoning for this goes back to lien priority. Since the second mortgage cannot be secured until the borrower has built up at least 20 percent equity in a home, the secondary mortgage is originated well after the first. No matter who files the foreclosure, the first mortgage was always the first to file the original lien, and is always in first position when it comes to payment.

References

• Debt Workout: Bankruptcy Alternatives
• The Bankruptcy Site: Secured Versus Unsecured Debt
• Advantage Credit Counseling: Unsecured Versus Secured Debt