Frequently, homeowners have more than one mortgage on their property, as well as judgment liens in some cases. For example, suppose you took out a second mortgage—along with a first mortgage—to cover the purchase price of your home, you then got a home equity loan to cover home repairs or remodeling, and a credit card company sued you and got a judgment lien. You then fell behind in your mortgage payments and the lender started a foreclosure.
Read on to learn what happens to your second mortgage, home equity loan, and the judgment lien in the foreclosure.
Here are the basics on mortgages, second mortgages, and judgment liens.
When you take out a loan to buy a home, you're usually required to sign two documents: a promissory note and a mortgage (or deed of trust).
Promissory Note. The note is your promise to repay the amount borrowed.
Mortgage (or deed of trust). The mortgage (or deed of trust) gives the lender a security interest in your home and permits it to foreclose on the property if you fail to make the monthly payments to repay the loan. (Learn more about the difference between a promissory note and a mortgage, as well as the difference between a mortgage and a deed of trust.)
Often, homeowners obtain a second mortgage when purchasing their property or, in some cases, later decide to take out a home equity loan or home equity line of credit. Second mortgage lenders, just like first mortgage lenders, will often require that you sign a promissory note and a contract that pledges the property as collateral for the loan.
There might be other liens on the property as well, like 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 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 lien priority.)
The priority of liens establishes who gets paid first following a foreclosure sale. “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, like 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.
But if the property had sold for only $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.
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.
If the second mortgage lender does not receive enough money from the first mortgage lender’s foreclosure to satisfy the debt (and assuming you've stopped making the payments), 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. So, the second mortgage lender can sue you on that promissory note. Because second mortgage lenders frequently receive little or nothing from a foreclosure sale, it's not surprising that they often take this route to attempt to get paid. (To learn more, see What Happens If I Don't Pay My Second Mortgage?)
A judgment creditor will also lose its security interest in the property following a 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, like by freezing your bank accounts or garnishing your wages. (To learn about other ways creditors can collect, see How Creditors Enforce Judgments.)
If you're facing a foreclosure and have multiple liens on your property, consider talking to a foreclosure attorney to find out what will happen to those liens and to learn about various options in your particular circumstances.