| Do Junior Liens Get Wiped Out?
There still 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 judgments? Here are the
answers to all of these questions.
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 Judgments?
A judgment is the result of a
claim filed against an individual through a court action. A successful
claim results in a judgment against all real and personal property
belonging to the individual (just like the IRS). A judgment takes effect
from the date it is recorded. It therefore has no special priority.
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