Liens, which are tied to the title of a home, can oftentimes survive foreclosure.
When a homeowner takes out a mortgage, the bank will place a mortgage lien on the property with the home serving as collateral for the loan. If the homeowner ceases to make payments on the mortgage loan, the bank will call the lien and foreclose on the property. If a home carries more than one lien, they may also be called during foreclosure, depending on when they were filed.
Liens attached to a property are secured by the property itself, therefore, the homeowner is not allowed to sell the property without settling all outstanding debts. During the foreclosure process, all junior liens are cleared yet the debt remains for the former homeowner since they are no longer secured by the property. Creditors who have had their liens cleared by the foreclosure process may seek other forms of compensation for debt, such as bank levies or the garnishment of wages.
When a primary lien holder forecloses on a property, all private liens placed on the property are cleared. For example, when a first mortgage is foreclosed, any second and third mortgages are cleared. While lien holders for the second and third mortgages may be able to recover their losses, they cannot attach any liens against the property after the foreclosure sale, meaning property purchased at a foreclosure sale initiated by the first mortgage holder will be clear of mortgage liens.
The priority of a lien is dictated by the filing date. Since banks file liens against property as part of the mortgage loan process, this lien has the highest priority. Any subsequent liens, including federal tax liens, that are filed becomes a junior lien and is prioritized based on the date it was field. Junior liens may exercise the same foreclosure rights as mortgage liens, but if a junior lien holder initiates a foreclosure proceeding, the superior liens will remain with the home.
When a creditor forecloses in a property, they must inform all lien holders of the process, they are not responsible for compensating the junior lien holders before selling the property. The foreclosure process will discharge all junior liens from the title, which allows the foreclosing creditor to proceed with the sale of the property without making the new homeowner responsible for the previous homeowners outstanding liens.
While liens are prioritized based on their filing date, government liens may supersede other types of liens, meaning foreclosure properties can carry additional tax liens. IRS liens are usually cleared after foreclosure because the IRS rarely sells property to collect a debt. Property tax liens, however, remain with the property regardless of the foreclosure. When purchasing foreclosed properties, buyers should complete a title search to see if the property owes back-property taxes.
Federal tax liens, which result from the failure of the homeowner to pay income taxes, are imposed by the IRS on the property, which gives the IRS the right to foreclose on the home to collect the outstanding debt. This right, however, is only be enforced if there is enough equity in the home to cover superior liens, such as a mortgage loan, as well as the IRS debt.
Deed-in-Lieu of Foreclosure Transactions
In order to avoid foreclosure, homeowners may resort to a deed in lieu of foreclosure, which forfeits the deed to the house to the bank. Banks are wary of this transaction since any other existing liens on the property, such as a second mortgage or judgment liens, will remain. A foreclosure, on the other hand, will clear any junior liens, which is financially beneficial to the lender.
According to the American Bar Association, “A deed in lieu of foreclosure does not “wipe out” any subordinate liens, and the grantee-mortgagee takes subject to all existing liens, whether known or unknown. To attempt to eliminate these liens, the lender still must foreclose the mortgage or otherwise deal with each of the existing encumbrances. The lender actually may have an incentive to pay something on lien claims to avoid a contested foreclosure proceeding; after all, the primary purpose of a deed-in-lieu transaction usually is to avoid foreclosure.”
Though foreclosure clears liens from the property’s title, the homeowner may still be responsible for those debts. A mortgage contains both a promissory note, a written promise to pay back the loan, and the mortgage, which is secured by the property itself. Though the bank may assume possession of the property if the mortgage loan is unpaid, the homeowner may still be responsible for the remaining debt after the home is sold under the promissory note. In some states, lenders can request a deficiency judgment from the court for the outstanding balance not covered by the foreclosure sale. When seeking a court judgement, a lender may request liens against other property, such as cars or second homes, to secure the remaining debt.
Lien regulations vary from state to state. In thirty states, as well as the District of Columbia, cities have the legal right to sell property-tax liens to private debt collectors. These agencies can charge interest rates as high as 50 percent on the outstanding debt, as well as add legal fees and other costs incurred while dealing with a delinquent homeowner. If the homeowner isn’t able to pay their back taxes, penalties and fees within a set timeline, which can range from six months in D.C. to four years in South Dakota — counties authorize tax-lien holders to initiate the foreclosure process to sell the property and settle the outstanding debt.
In some cities, unpaid water, sewer and municipal fees can result in liens that eventually lead to foreclosures.
Protections for Homeowners
Certain cities provide protections for homeowners with outstanding liens. New York, for example, won’t allow tax liens on homes owned by low-income seniors, people with disabilities and veterans to be sold to private companies. Also, certain counties in Michigan have eliminated tax-lien sales and instead provide homeowners in distress with payment plans, and Maryland limits legal fees in tax-lien cases to $1,500.
A 2013 Washington Post investigation revealed that nearly 500 homes had been lost through tax lien sales and foreclosures with a third of homeowners owing less than $1,000 in taxes. According to the Legal Counsel for the Elderly, many of the owners were also older and ill residents.
“In our work to helping them avoid tax sale foreclosure we came to see that the system was terribly unfair so we started talking about trying to fix the system,” said Joanne Savage, with Legal Counsel for the Elderly.
As a result of the investigation, a 2014 D.C. law was passed limiting when liens can be sold to investors, and returning equity to homeowners after taxes and fees are settled.
According to The Washington Post, “The liens then were sold at public auctions to private investors who drew a profit by charging owners interest on top of the tax debt until the money was repaid. Attorneys for the city argued that because the homeowners couldn’t pay their tax debts on time they then gave up their rights to their properties.
“The District government has agreed to pay about $1 million to settle a federal class-action lawsuit brought by homeowners to stop tax-lien investors from taking homes in the city through foreclosure, attorneys for both sides said.”
The District eventually “agreed to pay up to 65 percent of a property’s assessed value to homeowners or surviving relatives whose residences were taken by an often-abusive tax-collection system in which even small tax debts triggered property sales,” according to attorney Bill Isaacson of the Boies, Schiller & Flexner.