What Happens to Liens and Second Mortgages in Foreclosure?

Often, homeowners have more than one mortgage on their property. The property might also be subject to a judgment lien or other types of property liens.

For instance, suppose you took out a second mortgage, along with a first mortgage, to cover the purchase price of your home. Then, 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.

What happens to your second mortgage and the judgment lien in the foreclosure? Read on to find out.

What Is a Lien and How Does It Work in Foreclosure?

A "lien" is a claim against real estate to secure payment of a debt. The lien essentially makes the property collateral for a debt.

What Is a First Mortgage?

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). The mortgage creates a lien on the property. This kind of lien is called a "first mortgage." If you fail to make the payments, the home acts as collateral for the loan and the lender can foreclose.

A mortgage lien is considered a "voluntary" lien because you agree to the lien.

What Is a Second Mortgage (or Third Mortgage) and How Is it Different From a First Mortgage?

Homeowners sometimes take out a second mortgage when purchasing their property or, in some situations, decide to take out a home equity loan or line of credit. Second mortgage lenders (and third-mortgage lenders), 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.

A second (or third) mortgage is lower in priority (see below) than a first mortgage. Second and third mortgages are also voluntary liens.

Other Kinds of Liens

You might also have other liens on your property, like a judgment lien. If you're 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 in the land records, which is a lien that attaches to your real estate. This kind of lien is an "involuntary" lien.

How Lien Priority Works

Priority determines how foreclosure funds are distributed. Generally, the priority of a lien is determined by its recording date. But some liens, like property tax liens, have automatic superiority over most prior liens.

First mortgages are, as the name suggests, typically recorded first and are in the first lien position. Second mortgages are often recorded next and are usually in the 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.

How Does the Foreclosure Process Affect Liens and Second Mortgages?

Again, the priority of liens establishes who gets paid first following a foreclosure sale. "Senior" liens, like first mortgages, are paid before "junior" liens (those with lower priority), such as second mortgages.

Also, a foreclosure by a senior lienholder, such as a first mortgage holder, eliminates junior liens, such as second mortgage and judgment liens.

What Happens to a Second Mortgage in a Foreclosure Sale?

After a first mortgage lender forecloses and it's lien is paid off with the proceeds from the sale, any surplus funds from the foreclosure sale are distributed to creditors holding junior liens, like a second mortgage lender or judgment creditor (a person who sued you and won a judgment).

For example, say the total debt owed on your first mortgage is $200,000. You have a second mortgage on your home for $40,000, and a creditor filed a $10,000 judgment lien. Your home then sells to a third-party investor for $250,000 at a foreclosure sale. The first mortgage lender will be paid in full ($200,000). The second mortgage lender will be paid off 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 no debt remains.

However, 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. But that doesn't mean that those debts disappear. They become unsecured debts.

Are Second Mortgages Completely Wiped Out in Foreclosure?

Foreclosure eliminates liens, not debt. When a first mortgage lender forecloses, people often mistakenly think that the second mortgage and any judgment liens have also been satisfied—even if the foreclosure sale didn't bring in enough funds to pay off those debts. They're 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's title. However, the second mortgage debt and creditor's judgment remain, even though they're no longer attached to the foreclosed property. While the security for the debt has been eliminated, the obligations remain in place.

So, the Second Mortgage Lender Might Sue You

If the second mortgage lender doesn't receive enough money from the first mortgage lender's foreclosure to satisfy the debt and assuming you've stopped making the payments on that loan, it might sue you in court for the difference (as long as state law doesn't prohibit this action).

Remember the promissory note you signed when you took out the second mortgage? That was your promise to pay. So, the second mortgage lender can sue you based 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.

Judgment Liens Can Attach to Other Property

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 might have been eliminated from that particular piece of real estate, it will still attach to any other real estate 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.

Can a Second Mortgage Holder Foreclose Before the First?

A second mortgage holder can foreclose on your home even before a first mortgage. The more your home is worth, the more likely a second mortgage holder will foreclose if you stop making payments. Here's why: If you stop making payments on a second mortgage but remain current on the first mortgage, the senior lienholder (the first mortgage) still has priority. The junior lienholder (the second mortgage holder) would have to pay off the entire first mortgage or foreclose subject to the first mortgage.

So, a second mortgage holder will usually only foreclose if your home is worth enough to cover the first mortgage and all or part of the second.

Alternatives to Foreclosure for Second Mortgage Holders

If you owe more on your first and second mortgages than your home is worth, a second mortgage holder probably won't foreclose because it doesn't make financial sense. Say your home is worth less than what's owed on the first mortgage. In this scenario, the second mortgage holder wouldn't get any of the proceeds from a foreclosure sale. So, the second mortgage holder might look for other ways to collect from you, like filing a lawsuit for a money judgment if state law allows it.

Can Bankruptcy Help Eliminate a Second Mortgage?

If your home's value has gone down you since you purchased it, filing for Chapter 13 bankruptcy might help you to get rid of a second mortgage through a process called "lien stripping." With lien stripping, a bankruptcy court basically converts your second mortgage into an unsecured debt and orders the lender to release its lien from the property.

The mortgage debt is then reclassified as nonpriority unsecured debt, like medical and credit card debt. As part of the Chapter 13 process, you then pay your disposable income toward the unsecured debts, including the mortgage loan. If you complete the Chapter 13 plan, anything leftover on the mortgage debt is discharged (wiped out)

Getting Help With Your Second Mortgage Foreclosure Questions

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.