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March 18, 2008 5:00 PM

More on buying a foreclosed property with multiple liens against it

Posted by Elizabeth Rhodes

Responding to a recent Home Forum Extra item about a foreclosure clouded by an IRS lien, a reader asks: "If all liens get wiped out after the tax foreclosure auction and even if the IRS doesn't redeem the property or buy you out after 120 days, what's left to worry about? "

A: The worry is that all the liens didn't get wiped out. And that certainly can happen. Here's how.

All liens against a property are ranked, with the primary mortgage being No. 1. That's called being in first position. Any other liens are "junior" to that and are assigned a position.

They can include federal and local tax liens, court judgments for bad debts, unpaid child support or loans, etc. Any one of those can instigate a foreclosure to force payment, which will come from the home's sale.
It's not uncommon for a distressed homeowner to have two or three liens, and some have many more. Recently I saw a local home that had seven.

Here's an example of how the purchaser of a foreclosed home with tax and other liens can end up responsible for a leftover lien.

In this scenario:
First position: The mortgage.
Second position: An IRS lien.
Third position: Unpaid child support.
Fourth position: A home equity line of credit.
Fifth position: A lien placed to collect money awarded in a legal dispute.

Commonly it's the mortgage holder, in first position, that triggers the foreclosure. If the homeowner can't pay what's owed, the home is sold to the highest bidder (or if it doesn't sell the mortgage holder takes the home back).

All liens below the one that forced the foreclosure (i.e. the mortgage holder) are wiped out including the IRS lien, although the IRS retains a 120-day right to redeem the property from a new owner.

Let's say instead that the foreclosure is instigated by the lien holder that is owed child support. That lien is in third position. The two liens below it are wiped out. But the two above it are not. They remain with the property, so anyone who buys it in a foreclosure inherits the responsibility for paying off lien one (the mortgage) and lien two (the IRS bill).

That's why experienced foreclosure investors pay close attention to liens and their positions. It's also why some homes, even deeply discounted ones, don't sell at foreclosure. The pros know that the discounted price is deceptive. The real cost can be much higher.

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