Thursday, September 01, 2005

Lien Holders Must Get In Line for Payment

A title search is one of the most important activities of the real estate transaction. Without the ability to convey title, a property owner cannot sell his or her home and a buyer would not want to take possession without this most basic exercise.

"Title" is the right to own land. Thus a title or settlement company conducts searches at the courthouse to determine if one owner has a "clear" title so that they can pass the property over to another owner. If a title has liens or judgments against it, then it creates a "cloudy title" and that's not a good thing, unless the liens are the most common sort, such as a mortgage.

Liens are "a charge or claim against a person's property, made to enforce the payment of money," according to my old principles of real estate text book, "Modern Real Estate Practice," published by Dearborn Real Estate Education. These liens are broken down into two major groups: voluntary (you actually created the lien intentionally, like a mortgage) and involuntary (it was forced on you, like taxes or a creditor's lien seeking payment).

Beginning investors need to be careful that when they go to the courthouse steps to bid on a property, that when they "win" they haven't just purchased a bunch of liens, which are attached to the property and convey with the property. Keeping in mind that if someone has allowed their house to go to foreclosure, then they've had financial problems and that means they could have had liens placed on the property from vendors seeking payment.

As mentioned above, mortgage companies place liens on the property for the mortgage amount. Other liens could be placed on the property for taxes, fees outstanding to contractors (mechanics lien), and even homeowners association dues. You may even find liens for utility companies and local creditors.

When a house goes to foreclosure, the lien holders must get in line for payment. The first one with a hand out is the government for taxes. This lien is the first in priority, even though the general rule is "first-come, first-served." All other lien holders better hope they placed a lien on the property early on.

For example: Mr. Smythe is ordered to go to foreclosure on his home and is able to receive $275,000. He has a tax lien for $5,000 the current year, a first trust mortgage from 1998 for $125,000, a judgment lien from a creditor for $100,000 from 2003, and a mechanics lien for work done by a contractor on his deck for $20,000 from 2002.

The order of payoff would be as such:

Taxes: $5,000

1st Trust: $125,000

Mechanics lien: $20,000

Judgment lien from creditor: $100,000

Mr. Smythe: $25,000
The seller receives the balance of the proceeds (and that's assuming the creditors have not sued him for the cost of the foreclosure or any fees they've incurred that they are allowed to because of the foreclosure).

If Mr. Smythe goes to foreclosure in a down market and only receives $200,000, the roll out of the proceeds may look like this:

Taxes: $5,000

1st Trust: $125,000

Mechanics Lien: $20,000

2nd Trust: $50,000

Mr. Smythe: $0
In many foreclosure cases, the mortgage company will pay the taxes just so they can get first in line for their own money. The only other way a creditor can move ahead in the line may be through a "subordination agreement" between them and another lien holder to change the priority (you might say these are also considered a "fat chance" agreement or "snow ball's chance" agreements). Not too many companies are willing to subordinate to other creditors if they don't have to.

If you find yourself in a must-sell situation, it's best to let your agent know immediately that you might have liens on your property -- she'll find out about it eventually during the title search. For those facing foreclosure, you may have creditors judgment liens on your house and not even know it. The only way to find out about them is to visit the courthouse and look at your records. Obviously, the only way to remove the liens is to pay them off.

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