What Happens to Liens and Second Mortgages in Foreclosure?
Learn how liens and second mortgages get paid off in foreclosure, and your liability for the underlying debt afterwards.
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Frequently, homeowners have more than one mortgage on their property, as well as judgment liens in some cases. For example, you took out a second mortgage along with the first mortgage to cover the purchase price of your home, you got a home equity loan to cover home repairs or remodeling, or a credit card company sued you and obtained a judgment lien. Read on to learn what happens to second mortgages and judgment liens in a foreclosure.
What are Mortgages and Liens?
Here are the basics on mortgages, second mortgages, and liens.
Mortgages and Promissory Notes
When you take out a loan to purchase a home, you are required to sign two documents: a promissory note and a mortgage. The note is the promise to repay the amount borrowed. The mortgage gives the lender a security interest in your home and permits it to foreclosure on the property if you fail to make the monthly payments.
(To learn more about mortgage terminology, see our Glossary of Foreclosure Terms.)
Often, homeowners obtain a second mortgage when purchasing their property or, in some cases, later decide to take out a home equity loan. Second mortgage lenders, just like first mortgage lenders, will require that you sign a promissory note and a mortgage that pledges the property as collateral for the loan.
There may be other liens on the property as well, such as a judgment lien. If you are sued in court for a sum of money and lose the case, the prevailing party will be granted a judgment. That party may then file a judgment lien, which is a lien that attaches to your real estate. To learn more about judgment liens, see our article What is a Judgment Lien?
Generally, the priority of a lien is determined by its recording date (though some liens, such as property tax liens, have automatic superiority over essentially all prior liens). First mortgages are, as the name suggests, typically recorded first and are in first lien position. Second mortgages, which are often recorded next, are usually in second position. Judgment liens are frequently junior to a first mortgage and possibly a second mortgage, as well as perhaps other judgment liens previously filed by other creditors. Learn more about types of property liens.
Priority Determines How Foreclosure Funds Are Distributed
The priority of liens establishes who gets paid first following a foreclosure. “Senior” liens are paid before “junior” liens (those with lower priority). After the first mortgage lender forecloses, any surplus funds from the foreclosure sale after the foreclosing lender’s debt has been paid off will be distributed to creditors holding junior liens, such as a second mortgage lender or judgment creditor (the person who sued you and won the judgment).
Example. Say the total debt owed on the first mortgage is $200,000. There is a second mortgage for $40,000 and a $10,000 judgment lien. The home then sells for $250,000 at the foreclosure sale. The first mortgage lender will be paid in full ($200,000). The second mortgage lender will be paid in full as well ($40,000). The judgment creditor will be paid whatever is left ($10,000). In this case, all creditors were paid in full and zero debt remains.
However, if the property had only sold for $200,000 at the foreclosure sale, the total amount would go to the foreclosing lender. The second mortgage lender and the judgment creditor would receive nothing and their liens would be wiped out in the foreclosure. However, this does not mean that the debt disappears.
Foreclosure Eliminates Liens, Not Debt
When a first mortgage lender forecloses, people often mistakenly think this means the second mortgage and any judgment liens have been satisfied as well, even if there were not sufficient funds to pay off the debts. They are then surprised when the second mortgage holder or judgment creditor seeks to have the outstanding balance on their debt paid.
Following a first mortgage foreclosure, all junior liens (including a second mortgage and any junior judgment liens) are extinguished and the liens are removed from the property title. However, the second mortgage debt and creditor’s judgment remain, even though they are no longer attached to the foreclosed property. While the security for the debt has been eliminated, the obligations remain in place.
The Second Mortgage Lender May Sue You
If the second mortgage lender does not receive enough money from the first mortgage lender’s foreclosure to satisfy the debt, it can sue you in court for the difference (as long as state law does not prohibit this action). Remember the promissory note that you signed when you took out the second mortgage? That was your promise to pay. The second mortgage lender can sue you on that promissory note. Since second mortgage lenders frequently receive little or nothing from a foreclosure sale, it is not surprising that they often take this route to attempt to get paid.
Judgment Liens Can Attach to Other Property
The judgment creditor also loses its security interest in the property following the first mortgage lender's foreclosure. However, while the judgment creditor's lien may have been eliminated from that particular piece of real estate, it will still attach to any other real estate that you own now or in the future. Plus, the judgment creditor can try to collect the debt in other ways, such as by freezing your bank accounts or garnishing your wages. To learn about other ways creditors can collect, see Debt Collection: Repossession, Wage Garnishments, Property Levies, and More.