There seems to be a lot of confusion about what happens to
junior debts at a foreclosure auction. Do junior debts get wiped out? What
about property tax liens? What about IRS liens? What about mechanics' liens?
What about judgements? I've seen these questions asked over and over at
several newsgroups. Rather than spend the time responding to all of those posted
questions, I've decided to answer them here.
Do Junior Debts Get Wiped Out?
The answer is that junior debts can be wiped out if there
isn't enough money generated by the auction. Let's review the following example to
clarify this point. The 1st trust (or mortgage) lender has initiated a foreclosure
on a property with the following debts. The 1st trust balance is $60,000 including
arrears (back payments) and foreclosure costs. The 2nd trust balance is $20,000
including arrears. There is a hospital lien of $8,000 that was filed after the 2nd
trust. There is a 3rd trust, filed after the lien, with a balance of $12,000.
The total debt is $100,000 ($60,000 + $20,000 + $8,000 + $12,000).
Assume that the market value of the property is
$120,000 and that you, as an investor, would probably not pay more than 70% of value or
$84,000. Obviously, you would not buy this property before the auction because all
of the debt ($100,000) remains on the property before the auction. Your best bet would be
to wait until the auction to buy the property. Let’s say that you were the
successful bidder at the auction with a high bid of $84,000.
The sale proceeds would be distributed as follows. The first $60,000 goes to the
1st trust lender. The next $20,000 goes to the 2nd trust
lender. The remaining $4,000 goes to the hospital. There is nothing left for
the 3rd trust lender. The 1st and 2nd trusts are
completely satisfied. The hospital lien is partially wiped out because the hospital only
received $4,000 out of the $8,000 that was owed. The 3rd trust is
completely wiped out because there is no more money left.
This simple example should explain what happens to junior debts at foreclosure.
Junior debts can be completely satisfied, partially satisfied (or partially wiped out
depending on your point of view), or completely wiped out, based on the amount of money
bid at the auction.
What About Property Tax Liens?
As you noted in the above example, debts (trusts/mortgages
and other liens) are ranked based on the order in which they are filed. The primary
exception to this rule are property tax liens. Because property tax liens represent
money owed to the county, and ultimately to the state, states have placed these liens at
the highest priority. Tax liens therefore take precedence over all previously
recorded debt, regardless of when they were filed. This means that a tax lien on a
property must first be satisfied before the other debt.
What About IRS Liens?
IRS liens are general liens which means they can attach to
all real and personal property belonging to a particular owner. Unlike a property
tax lien, an IRS lien takes effect from the date it is recorded. It does not take
priority over previously recorded debts. Note however that even if there isn't
enough money to satisfy an IRS lien at an auction, the lien is not automatically wiped
out. The IRS will sometimes pursue the debt that is owed on a foreclosed property
after the auction.
What About Mechanics' Liens?
A mechanic's lien is established when a contractor files a
claim for non-payment of the work performed on an owner's property. The lien
generally takes effect from the date it is recorded. However, some states give this
lien a higher priority, which means that it may have to be satisfied before the remaining
junior debt.
What About Judgements?
A judgement is the result of a claim filed against an
individual through a court action. A successful claim results in a judgement against
all real and personal property belonging to the individual (just like the IRS). A
judgement takes effect from the date it is recorded. It therefore has no special
priority.
Source: teamforeclosure.com
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