Foreclosure, Liens, and the First in Time, First in Right Rule
The First in Time, First in Right rule establishes the priorities of liens recorded against your home, which dictates who gets paid in the event of a foreclosure.
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In property law, there is a general rule that an entity whose interest in a property is first established prevails over a party who subsequently acquires an interest in the property. This rule is known as the first in time, first in right rule. The priority of an interest in a property is established by recording a notice of the interest in the county records of the county in which the property is located. An interest recorded before a subsequently recorded interest, following this first in time, first in right principle, would have seniority over the subsequently recorded interest.
When purchasing a home, the mortgage obligation consists of two parts: a promissory note and a mortgage (or a deed of trust in some states). The promissory note is the personal promise to pay back the money borrowed to purchase the property. The mortgage or deed of trust, on the other hand, establishes the lender’s lien on the property and is recorded in the county records. In a typical home sale, the purchase money mortgage (the mortgage the buyer takes out to purchase the property) is recorded first and, in accordance with the first in time, first in right rule, has priority over all subsequently recorded junior mortgage liens, such as second mortgages and home equity lines of credit (HELOCs).
As with every other rule, there are exceptions to the first in time, first in right rule. Depending on state and federal laws, certain liens, such as those placed on property for the collection of property taxes, special assessment taxes, homeowners’ association (HOA) or condominium association (COA) assessments, and contractor fees, may have priority over purchase money mortgages and other liens recorded earlier.
The priority of a lien matters because, in the event of a foreclosure, the holder of the lien with the highest priority is paid first from the proceeds of the foreclosure sale. Only after that party is made whole does the holder of the next highest priority receive any of the money from the foreclosure sale, and on and on down the line of liens. If there isn’t enough money for all of the lienholders to get paid, the holders of the liens lower down on the chain are out of luck.
Here’s an example to help illustrate the importance of lien priority: Let’s say you purchase a home for $500,000. You put no money down and take out an 80/20 loan, which consists of a $400,000 first mortgage and a $100,000 second piggyback mortgage loan. You then decide to do some repairs on the home before moving in and borrow $50,000 from a friend; the loan is also secured by your home. During construction, a neighbor slips and falls on some wet cement on your property. The neighbor sues you and wins a judgment of $2,500. You refuse to pay, so the neighbor places a lien on your home to collect on the judgment. The priority of the liens is as follows:
- $400,000 first mortgage
- $100,000 second mortgage
- $50,000 third mortgage
- $2,500 judgment
Now imagine that, while you’re still working on your home, which is now gutted and worth only $425,000, you lose your job and you stop paying your mortgage. If the bank that loaned you $400,000 forecloses, and the home sells for what it’s worth at the foreclosure auction, who gets paid? The holder of the first mortgage gets $400,000 from the foreclosure proceeds and is made whole. The holder of the second mortgage only gets the remaining $25,000, even though it loaned you $100,000. Depending on the laws of your state, the second lienholder may or may not be able to sue you to recover the remaining $75,000, which is called a deficiency. (To learn more about deficiencies and to find out whether lenders can sue you for a deficiency, see our article on Anti-Deficiency Laws.) What about your friend and the neighbor? They get no money from the foreclosure, and their liens are now worthless. However, they can still try to collect the debt from you in other ways (for example, your friend could sue you and then freeze your bank accounts, garnish your wages, or place liens on other property you may own).
The First in Time, First in Right Rule and Tenants
Even though a tenant doesn’t have a recorded lien on the property it rents, the tenant does have an interest in the property based on the time the tenant’s lease goes into effect. According to the first in time, first in right rule, if a mortgage is recorded against the property before a tenant enters into a lease, and the lender forecloses, the lease should be terminated by the foreclosure.
However, a federal law, the Protecting Tenants at Foreclosure Act of 2009, provides relief to some tenants. Under this law, the tenant’s lease survives the foreclosure and the new owner takes the property subject to the terms of the lease. (Month-to-month tenants without a lease must be given 90 days’ notice to vacate.) In other words, the tenant can remain on the property until the end of the lease term, as long as the tenant meets all of its obligations under the lease, such as paying rent to the new owner. If the new owner intends to occupy the property, however, the lease may be terminated with 90 days’ notice.
The Protecting Tenants at Foreclosure Act is set to expire on December 31, 2014.