Some liens have "priority" over others. A lien with priority gets paid first out of the proceeds from a foreclosure sale. For example, a first lien has priority over a second lien and gets paid from foreclosure sale proceeds before a second lien. A second lien gets paid before a third lien, and so forth.
Because a foreclosure sale brings in a limited amount of money (sometimes less than the borrower owes to the first mortgage lender), a second mortgage lender and other low-priority lien holders sometimes don't receive any of the proceeds from the foreclosure sale.
How Lien Priority Works
Liens usually follow the “first in time, first in right” rule, which says that whichever lien is recorded first in the land records has higher priority than later recorded liens. However, some liens, like property tax liens, automatically get priority over almost all earlier liens.
A lien with priority over another lien is called a "superior" lien. A low-priority lien is called a "junior" lien.
If a home has more than one lien, lien priority determines the lienholders’ rights following a foreclosure sale.
What Are Some Common Kinds of Liens?
Often, a property is subject to more than one lien. Some liens, like mortgage liens, are "voluntary," which means the homeowner chooses to put the lien on the home. Other liens, like homeowners’ association, municipal, judgment, and mechanic’s liens, are "involuntary."
How Mortgage Liens Work
The most common type of a first lien is a mortgage. Usually, when you buy a home, the lender pays for a title search before giving you the loan money to make sure the property has clear title. If title to the home is clear, you'll probably sign a mortgage (or a deed of trust) to secure the debt. The lender will then record the mortgage (called a "first mortgage") in the county records or other public land records to create a lien on your property.
If you take out another loan, like a home equity loan, from a different lender, the second lender will record it and also get a lien on the property. Most subsequently-recorded liens, like judgment liens (see below), are inferior to mortgage liens.
What Are Homeowners’ Association Liens?
If you fail to pay your homeowners' association (HOA) dues, the HOA often automatically gets a lien on your home. Most HOA liens are junior to a first mortgage based on the terms of the Declaration of Covenants, Conditions, and Restrictions. However, if your state has a super-lien statute, the HOA lien might be superior to the mortgage lien.
Even if the HOA lien is junior to the mortgage lien, the HOA could potentially foreclose on your home and evict you from the property. But because the lender still has a first lien on the property, it has the right to then foreclose on the HOA. For this reason, HOAs usually don't foreclose junior liens.
County Tax Liens Can Eliminate a Mortgage
County tax liens are very serious liens because they can wipe out the interest of a first lien mortgage. In fact, tax liens are superior to almost all other types of liens.
If you or your loan servicer don't pay the taxes on your property, the property might go to a tax sale. If a tax sale happens, both you and the lender could lose the property to a third party for the nominal amount of the taxes due. Because a tax sale can wipe out a lender's lien, mortgage servicers often pay property taxes even if a homeowner doesn't.
How Municipal Liens Work
If a condition on your property violates a local ordinance, like a broken window or unkempt yard, the county or municipality may require you to correct the issue. If you don't, the municipality might fix the problem itself and charge you for the work. If you don't pay, it will place a lien on the property for the unpaid amount. Unlike many other types of liens, municipal liens are a type of superior lien.
What Are Judgment Liens?
Judgment liens are one of the most common types of junior liens. When a person defaults on a debt, the creditor may sue the debtor to attempt to collect the debt. If the creditor gets a judgment against the debtor in court, the creditor can attach that judgment to any real property that the debtor owns.
How Mechanic’s Liens Work
If you elect to have major work done to your home, like putting on a new roof, installing a new air conditioner, or completing major renovations, the contractor could file a mechanic’s lien on the property if you don't pay your bill. This kind of lien can sometimes be superior to a first lien mortgage. The contractor could potentially elect to foreclose on your property to force payment of the lien.
Example of How Lien Priority Works
Say you buy a home and now owe $500,000 on that first mortgage. You also took out a home equity loan for $15,000. In addition, a credit card company sued you for nonpayment and got a $6,000 judgment lien on your home. You don't make the mortgage payments for your first mortgage and the lender forecloses. The home sells for $520,000 at the foreclosure sale.
The priority of the liens is:
- $500,000 first mortgage
- $15,000 home equity loan (second mortgage), and
- $6,000 judgment lien.
The first mortgage lender gets paid $500,000, leaving $21,000 for the other lienholders. The home equity lender will get $15,000. The judgment creditor gets $5,000, but it loses out on $1,000, and its lien is eliminated by the foreclosure.
However, even though the lien is gone, you might not be off the hook for the $1,000 you still owe the credit card company. The credit card company might attempt to collect the judgment debt from you in other ways, like by levying your bank accounts, garnishing your wages, or putting a lien on other property you own.
More About Junior and Second Mortgages
Usually, a junior mortgage is a second mortgage, but not always. Depending on how much equity you have in your home, a lender might let you take out a mortgage that's even lower in priority, such as a third or fourth mortgage. (Think of "equity" as the amount of your home that you own. If your home is worth $500,000 and you owe $450,000 on it, you have $50,000 equity.) Junior mortgages, because they are lower in priority, usually have higher interest rates and lower loan amounts.
If you fall behind on your payments for a senior or junior mortgage, you might face a foreclosure. Whether and which mortgage holder will initiate a foreclosure (the first or a junior mortgage holder) often depends on your home’s value.
What Are the Different Types of Junior Mortgages?
Sometimes, a borrower takes out two mortgage loans to purchase a home. An 80/20 loan, commonly called a "piggyback loan," is a loan where the first mortgage pays 80% of the purchase price, and the second mortgage pays the remaining 20%. The mortgage covering the 20% gets recorded after the 80% mortgage and is a second mortgage. (An 80/10/10 loan works similarly but involves a first, second, and third mortgage.)
In some cases, the homeowner might also take out another mortgage after a first mortgage or an 80/20 mortgage deal, like a home equity loan or a home equity line of credit, sometime later. That equity loan would then be a second, third, or maybe fourth mortgage.
What Is the Difference Between a First Mortgage and a Junior Mortgage?
The main difference between a first mortgage and a junior mortgage is the priority and the level of risk when it comes to a borrower defaulting on payments. In a foreclosure, the junior mortgage might find itself unsecured (that is, the property sells at a foreclosure sale for less than what's needed to pay off all the mortgages).
Again, the interest rate on a junior mortgage is usually higher, and the amount you can borrow is typically lower than that of a first mortgage.
How Can I Get a Junior Mortgage?
Banks, credit unions, and mortgage companies offer junior mortgages to qualified borrowers.
What Are the Benefits of Having a Junior Mortgage?
Getting a junior mortgage could provide you with cash to pay off credit card debt or cover other purchases. But replacing unsecured debt, like credit card debt, with a secured debt, like a mortgage, is risky and typically a bad idea. If you default, you could lose your home.
What Are the Risks of Having a Junior Mortgage?
An increased risk of default is the most common risk associated with a junior mortgage for lenders. If the borrower fails to make the payments on a junior mortgage, the lender might not be able to recoup their funds through a foreclosure. This added risk is why lenders charge higher interest rates for junior mortgages compared to first mortgages.
For borrowers, the most significant downsides to having a junior mortgage are having to pay a higher interest rate, resulting in potentially high monthly payments, and the risk of foreclosure if you can't make those payments. If you run into financial difficulties, you might not be able to make the payments on the first mortgage or a junior mortgage. You could lose your home to foreclosure if you don't pay either or both.
What Happens If I Default on a Junior Mortgage?
If you default on your first mortgage, the first mortgage holder will likely foreclose. On the other hand, if you stop making payments on the second, you might or might not face a foreclosure.
The current value of your home will be the predominant factor the second mortgage lender will assess when determining whether to foreclose. Why? Because of priority. The lender in the second or junior position must fully repay the loan in the first spot before receiving a penny.
When you have equity in your home. If the market value of your home is more than what you owe the first mortgage holder, your second mortgage holder is likely to consider foreclosing. The reason is that the second stands to recover some or all of the money it loaned you after the first mortgage holder gets paid.
The more equity you have in the home, the more likely a second or junior mortgage holder will foreclose.
When you don't have equity in your home. If you owe your mortgage holders more than your home is worth, you have negative equity. This situation is also known as being “underwater” or “upside-down” on the property. Under these circumstances, even if the second mortgage holder foreclosed, the price at the foreclosure sale probably wouldn’t be sufficient to pay off what you owe.
So, if you're upside down and stop paying your second mortgage, that lender is unlikely to foreclose because it wouldn’t get anything out of the sale. However, it might be able to still sue you to get repaid.
How the Second Mortgage Holder Gets Paid
If a foreclosure doesn’t bring in sufficient funds to fully repay a second mortgage, the bank in this second position has limited options. Because the home is no longer available to sell, the second mortgage holder will probably file a lawsuit (unless state law prohibits it) in an action called a “suit on the promissory note.” The note you signed when you took out the loan gives the bank this right.
Once it gets a court judgment, known as a "deficiency judgment," you’ll have to repay the amount you still owe. You might face a wage garnishment or bank levy.
What Are the Different Ways to Pay Off a Junior Mortgage?
A few ways to pay off a junior mortgage include:
- making larger payments to pay it off early
- making a lump-sum payment or multiple lump-sum payments if you receive a large amount of cash from an inheritance, for example, or
- refinancing it into a first mortgage, perhaps to get a lower interest rate.
Or you might consider asking the lender if it would consider a short payoff (paying off the debt for a reduced amount in one lump sum.)
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Getting Help
If you're facing a foreclosure because of an unpaid lien, consider talking to a local attorney to learn about your rights and options. An attorney can advise you about ways to potentially settle the debt or fight the lien if it's invalid.