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January 30, 2008 9:00 AM

Lien holder wonders what happens when home is foreclosed

Posted by Elizabeth Rhodes

Q: What happens in a bank foreclosure when there are multiple liens against the property? Do the proceeds from the foreclosure sale also require payment to the other lien holders? Or does the title to the new owner remain clouded by the junior liens?

A: The lender that holds the main mortgage secures it with a lien that's in what's called "first position." Other debts are secured by "junior" liens in secondary positions. For example, there could be liens in second, third, fourth, even seventh and eighth position related to a home equity line of credit, unpaid taxes or child support, or a court judgment against the home's owner. Any of them, not just the entity in first position, can force a home into foreclosure to collect an unpaid debt.

Lance Olsen, managing attorney for Routh Crabtree Olsen in Bellevue, explains what happens to liens in a foreclosure.

Let's say ABC Mortgage is in first position, and John Doe has a lien in second position. ABC Mortgage instigates the foreclosure.

"If ABC completes its foreclosure, then John Doe's interest lien is eliminated," Olsen says, because it's in secondary position. All liens below his also are wiped out.

"In theory John Doe could still pursue the borrower for the amount owned because the debt doesn't go away -- just the security interest" that was held in place by the now-defunct lien.

There are two possible ways for John Doe to collect at least some of his money. The first is to hope that the property sells for more than the amount owed the lender because the lender can't keep any surplus. The court gets control of that money, and Doe can petition for what's owed him.

Otherwise, John Doe can sue the homeowner for the funds. However someone who loses their home because they can't pay their mortgage probably doesn't have money to pay Doe either. So suing to recover the debt is probably a waste of time, says Olsen.

If the foreclosure is instigated and completed by a junior lienholder, say one in second or third position, then the liens below the junior one automatically are wiped out. But the ones above it remain with the property.

That's a big reason why people who buy foreclosures need to be careful. Say a lien holder in second position forecloses to collect $75,000 owed. At the foreclosure auction, the house, worth $300,000 sells for $150,000 -- a seeming bargain for the buyer. But let's say there's also an outstanding $250,000 mortgage in first or senior position.

The winning bidder gets the house and the obligation to pay that $250,000 first mortgage, in effect paying $400,000 ($150,000 up front plus the $250,000 mortgage) for that $300,000 property.

If the new owner "doesn't pay off the senior, they're going to eventually get foreclosed as well," Olsen cautions.

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