Lien priority is important because, if a foreclosure occurs, the holder of the lien with the highest priority will be paid first from the foreclosure sale’s proceeds.
Understanding how priority works and where you fall in this chain is essential for lien holders.
If a foreclosure occurs, will you be paid your due?
How quickly will that occur?
Are there any exemptions?
Could you ever be out of luck entirely?
Keep reading to learn everything you need to know about lien priority.
1. What is a lien?
A lien is a claim or legal right against assets that are normally used as collateral to satisfy a debt.
If someone puts a lien on your property, your real estate will become effective collateral for a debt.
A lien has two distinguishing traits: voluntary or involuntary and specific or general.
Some property liens are voluntary because you agreed to that lien by taking out the loan.
An example of this is the mortgage lien.
However, other liens are involuntary because the lienor doesn’t need your consent before placing the lien.
Examples of involuntary liens include judgment liens, tax liens, and mechanic liens.
The second identifying characteristic of a lien is specific or general, and this simply identifies how many separate pieces of real estate it can be attached to.
A specific lien attaches to only one property while a general lien attaches to several properties.
An example of a specific lien is a mortgage.
An example of a general lien would be a tax lien.
2. What is lien priority?
Lien priority determines the order in which creditors get paid following a foreclosure.
The rule is normally “first in time, first in right.”
This says that whichever lien is recorded first in the land records has a higher priority than the later records.
For example, a mortgage will have priority over a judgment lien if the lender records it before a judgment creditor records its lien.
There are a few exceptions to this rule, and we’ll discuss them below.
3. What is a superior lien? What is a junior lien?
This is important terminology to understand when distinguishing lien priority.
A lien that has priority over another lien is known as a “superior” lien.
A low-priority lien is called a “junior” lien.
4. How does lien priority work with mortgages?
When buying a home, a borrower normally signs two important documents: a promissory note and a mortgage (or a deed of trust).
Promissory note: the personal promise to pay back the money borrowed
Mortgage or deed of trust: establishes the lender’s lien on the property and is recorded in the county’s records
In a typical home purchase, the mortgage will be recorded first.
This means it has lien priority over all subsequently recorded “junior” mortgage liens, such as a second mortgage or home equity lines of credit (HELOCs).
5. Why is lien priority so important?
We’ll illustrate the significance of lien priority with the following example.
You purchase a home for $500,000.
There’s no down payment, and you take out two loans consisting of a $400,000 first mortgage and a $100,000 second-mortgage loan.
Your house needs some additional repairs done.
To do these, you borrow $50,000 from a friend, and this loan is secured by your home.
However, during construction, a neighbor slips and falls on some wet cement that’s located on your priority.
The neighbor sues you and wins a judgment of $2,500.
You refuse to pay the sum, and unhappy with this situation, your neighbor places a lien on your home to collect the judgment.
The lien priority on your home is…
$400,000 first mortgage
$100,000 second mortgage
$50,000 third mortgage
Now, let’s take this scenario a step further.
While you’re still upgrading your home through construction (keep in mind that it’s only worth $425,000 at this point), you lose your job and stop making your mortgage payments.
If the bank that loaned you $400,000 forecloses, and the home sells for what it’s worth at the foreclosure action, who gets paid?
Here’s the order.
The holder of the first mortgage would get $400,000 and is made whole
The holder of the second mortgage gets the remaining $25,000 even though it loaned you $100,000
Note: depending on the state, this lienholder may be able to sue and recover the $75,000 – this is called a deficiency.
The friend and neighbor wouldn’t get any money from the foreclosure.
Their liens are now worthless.
While they can try to collect the debt in other ways, there are no guarantees.
Other methods to recover funds include suing you, freezing your bank account, garnishing your wages, or placing liens on other property you own.
Lien priority matters when there are multiple creditors and/or claimants who want to get paid — they need a piece of the pie.
The priority rules are laid out to serve the function of determining how the pie will be split.
Often, creditors will fight over the same piece of the pie, and this process makes it routine and fair.
6. What is the “first in time, first in right rule” as it applies to tenants?
This rule states that whichever lien is recorded first in the land records has a higher priority than the later records.
However, because a tenant doesn’t have a recorded lien on rented real estate, what happens then?
The tenant may not have a recorded lien, but they do have an interest in the property based on the time the lease goes into effect.
According to this rule, if a mortgage is recorded against a property before a tenant enters a lease and then the lender forecloses, then the lease should be terminated.
That said, a federal law (Protecting Tenants at Foreclosure Act of 2009) provides a release for some tenants.
This law says that a tenant’s lease generally survives a foreclosure, and the new owner takes the property subject to the terms of a lease.
If month-to-month tenants don’t have a lease, then they must be given 90 days’ notice to vacate.
So, a tenant can remain in the property until the end of their lease term if they’re fulfilling all the obligations of that existing lease (i.e., paying the new owner.)
That said, if the owner intends to occupy the property, then the lease may be terminated with 90 days’ notice.
7. What are the exceptions to lien priority?
The exceptions to lien priority often depend on state and federal laws.
For example, liens placed on a property for the collection of property taxes, special assessment taxes, homeowners’ association (HOA) or condominium association (COA) assessments, and contractor fees might have priority over first mortgages and other liens that were recorded earlier.
A county tax lien, for example, can wipe out the interest of a first lien mortgage.
Tax liens are superior to almost all other types of liens.
If a tax sale occurs, both you and your lender could lose the property to a third party for the nominal amount of the taxes due.
A tax sale can wipe out a lender’s lien, and thus, mortgage servicers will often pay property taxes even if a property owner doesn’t as it protects their interests.
8. What is the financial impact of lien priority?
Lien priority can become complicated — especially when the owner of a property simply doesn’t have the money to pay.
Knowing how lien priority operates in a particular state is incredibly important to recovering amounts owed.
However, there are several scenarios in which the merits of the claim may not matter.
Once multiple parties have established secure credit interests, they must wait their turn to have those claims paid out.
There may be parties with good claims that are not able to recover what is owed to them just because of their place in line.
For this reason, if you suspect there may be money troubles at some point in the process, it may make sense to actively file a lien to “get in line” earlier if it looks like there may be money troubles.
Just being in line before other valid claimants could be what determines if you actually recover your money.
9. What is a mechanic’s lien?
If you choose to have major work done to your home, like putting on a new roof, installing a new AC, or completing major renovations, you’ll likely need to work with a contractor.
However, if you don’t pay your contract for this work, then they could file a mechanic’s lien on the property.
This kind of lien is also superior to a first lien mortgage, and the contractor could potentially choose to foreclose on your property to force lien payment regardless of the wishes of your mortgage lender.
10. What are judgment liens?
Judgment liens are a common type of junior lien that occur when a person defaults on a debt.
The creditor may sue the debtor to try and collect the debt.
If the creditor gets a judgment against the debtor in court, then the creditor can attach that judgment to any real property that the debtor owns.
11. How do municipal liens work?
In some municipalities, conditions on properties could violate a local ordinance.
Examples of this include a broken window or an unkempt yard.
Your county or municipality is likely to require that you correct this issue, and if you don’t, then they may pay to fix it themselves and bill you for the work they did on your behalf.
If you don’t pay this sum, then they will place a lien on your property for the unpaid amount (a municipal lien).
Municipal liens are categorized as superior liens.
12. What are community association liens?
A community association lien, also known as an HOA lien, is a judgment lien that results from a court-ordered money judgment.
In this process, an HOA will go to court over an association member’s delinquent dues and attempt to convince the court to issue a judgment.
Association lienholders have a right to foreclosure properties to satisfy their liens.
Depending on the state, an HOA can foreclose for relatively little money and after short periods.
For example, in Michigan, an HOA can attempt a judgment after 30 days of a member’s indebtedness, record a lien, and move to foreclosure.
It doesn’t matter the debt size.
For another example, in California, HOAs can foreclosure when payment delinquencies reach $1,800 or are at least 12 months old.
Judgments and liens are a matter of public record.
HOAs typically record them through the county register of deeds offices.
Some states will allow for nonjudicial foreclosure (without courts).
In these scenarios, an HOA will record its property lien and hold a public foreclosure sale on its own without needing a court order.
13. How do liens limit ownership?
When a lien is attached to real estate, it can limit ownership in two ways:
First, it can mean that the property can be sold against your will to pay off the debt.
For example, for nonpayment of the mortgage or taxes.
Second, it can show up when you sell your property.
The new owner almost certainly won’t want to pay your bills, and therefore, you’ll have to pay them in order to clear your debts and remove the lien before the property sale can be finalized.
If you don’t have the money to pay for the debt when you’re selling the property, then the money can come from what you get from the sale.
Understanding lien priority can help you both as a debtor and as a lienor.
Lien priority determines which creditors get paid (first or at all) following a foreclosure, and, depending on the circumstances, it’s not certain that everyone will.
The general rule is “first in time, first in right.”
However, there are some key exemptions, such as property tax liens, special assessment taxes, and HOA/COA assessment liens that will have priority over previously recorded liens like mortgages.
If the government or your HOA isn’t getting paid, you could lose your property altogether.
Be sure to keep this in mind as a property owner or even as a contractor who works with property owners.
Needing to leverage liens against other people’s property until the money is paid back isn’t an ideal position to be in, but it could be necessary.
Additional ResourcesIf you are looking to buy affordable land, you can check out our Listings page. And before you buy land, make sure you check out Gokce Land Due Diligence Program. If you are looking to sell land, visit our page on how to Sell Your Land.
Would you like to receive an email with our latest blog/properties every Thursday?
Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.