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 1^st trust lender.  The next $20,000 goes to the 2^nd trust lender.  The remaining $4,000 goes to the hospital.  There is nothing left for the 3^rd trust lender.  The 1^st and 2^nd 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 3^rd 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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