Why should I worry about Liens? Are some Liens more important than others? Can a Lien lead to the loss of the underlying property? How can I remove a Lien? As a Note investor, a single unpaid debt can put an entire property at risk—and liens are the mechanism that make it possible!
Introduction
Liens are legal claims placed on a property to secure payment of a debt or obligation. They play a critical role in real estate because they determine who gets paid—and in what order—when a property is sold or foreclosed. Understanding the different types of liens and their priority is essential for lenders, investors, and property owners, as liens can significantly impact property value, ownership rights, and financial risk.
Types of Liens
There are many types of Liens. It is important to understand each one and understand what they mean, the impact on the property and how to remove them. There is a priority of Liens, and this priority may affect the status of your Note. As an investor, you want to ensure your seller financed Note is the top Lien on the property. Every state has different rules on priority, so it is important to consult local rules about priority of Liens.
Property Tax Liens
- A tax lien attaches to a property and must be paid when the property is sold or foreclosed.
- It has priority over mortgage liens.
- Delinquent taxes are often purchased by investors through tax certificate sales, earning interest. If unpaid after the redemption period expires, the lien holder may foreclose.
- Tax sales may result in the property being sold for less than market value and often less than the mortgage balance.
Avoidance Strategy:- The lender can pay the taxes and seek reimbursement from the borrower.
- This is often handled by setting up an escrow account.
HOA (Homeowners Association) Liens
Some states are “super lien” states, where HOA liens take priority over the mortgage.
Mortgage Liens (1st and 2nd Mortgages)
- If there is a 2nd Mortgage, the first mortgage (underlying lien) has primary priority.
- At times, investors use “wrap” mortgages to resell at a higher price while leveraging the original mortgage for the lender debt.
- The second mortgage or wrap mortgage is paid after the first mortgage in foreclosure.
Mechanic’s Liens
- Filed for unpaid construction or repair work.
- Typically junior to mortgage liens (lower priority).
IRS Tax Liens
- Super Lien states – IRS lien has priority over mortgage lien
- The IRS lien does not usually eliminate a mortgage lien, but:
- The lender must notify the IRS before foreclosure.
- At foreclosure, the IRS will typically release its lien so the lender can be paid.
Municipal Liens
- Includes unpaid water, sewer, and trash
- Whether they attach to the property depends on state and/or local law.
City Liens and Code Violations
- May or may not attach to the property (Varies by state or local jurisdiction).
- Often negotiable.
Judgments
- Includes court-ordered debts (e.g., child support or spousal support).
- Typically attach to the property but they are junior liens
Most Important for Mortgage Note Lenders
Always ensure the property tax is paid. Verify tax payment status by checking the county tax website or obtaining confirmation directly from the tax office. If the borrower is unresponsive, it is often advisable for the lender to pay any past-due property taxes to protect the collateral. As a lender, you may also establish an escrow account to collect funds for ongoing tax payments and ensure timely reimbursement.
As a lender, you want to maintain first lien position on the property. The exception is if you knowingly purchase a second lien position mortgage. Generally, the first lien in the timeline is the priority. This means the originating mortgage lien is the one first in line. If any other loans are made, such as a secondary mortgage, those are subordinate to the first mortgage lien.
Summary
As a mortgage note lender, a lien is placed on the property to help ensure repayment of the loan. The mortgage lien is beneficial and lowers the risk to the lender. However, other types of liens can increase risk and may reduce the likelihood of full repayment, so they must be carefully managed.
The key takeaway is that lien priority determines order of repayment, especially during foreclosure. Senior liens are paid first, while junior liens carry greater risk of not being fully recovered. Before lending on a property, a title search is essential to identify all liens attached to a property and assess potential financial exposure.
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