What Happens to Liens on a House That Was Foreclosed On?
When an individual neglects an unsecured debt to a third party, that creditor has the option to record a lien against the debtor's home. State laws vary regarding the procedure creditors must follow prior to placing a lien. Real estate liens allow creditors to collect the full balance the debtor owed should the debtor sell or refinance his home. Foreclosure often results in the termination of other lien holders' security interests.
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Typically, a foreclosure occurs when the homeowner stops making regular payments to her mortgage lender. Because a lien grants a lender or creditor a security interest in the homeowner's property, however, any lien holder has the right to initiate foreclosure proceedings and claim the collateral -- in this case, real estate -- as payment.
Significance
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A lien's priority order depends upon the date it was filed. A "superior" lien is any lien that takes precedence over another, "junior," lien due to possessing an earlier recording date. With few exceptions, a junior lien holder must pay off any superior liens when it forecloses on the property. Superior lien holders, however, are not obligated to pay off junior liens in order to take possession of the home.
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Effects
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After a lien holder forecloses, any junior liens that previously existed on the property are no longer valid. This strips junior lien holders of their security interests and reduces their liens to the status of unsecured debts. Depending on the debtor's state laws, these former lien holders may seek liens against other property, such as the debtor's vehicle, or pursue alternative collection options.
Exceptions
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The lien priority rule does not apply to the Internal Revenue Service. An IRS lien automatically attaches to all property the debtor owns, and most lien holders must pay off IRS liens before foreclosing on a home. Because this can threaten a mortgage lender's primary security interest, some states, such as Texas, allow mortgage lenders to bypass the IRS's right to immediate payment, provided the IRS receives adequate notice that the mortgage lender intends to foreclose. Only the primary mortgage lender's lien can take priority over a federal tax lien.
Considerations
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If the value of a home's liens exceed the value of the real estate itself, junior lien holders have little incentive to initiate foreclosure proceedings. Because superior liens must be paid in full before the junior lien holder can realize a profit from the sale, foreclosing on and subsequently selling the property would leave some junior lien holders owing money rather than gaining it. In addition, foreclosing on a home is an expensive undertaking. Thus, junior lien holders do not use foreclosure as a debt recovery tool as often as primary mortgage lenders and the IRS.
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