A general rule in property law says that whichever lien is recorded first in the land records has higher priority over later-recorded liens. This rule is known as the "first in time, first in right" rule. If more than one lien is recorded against a property, priority determines the lienholders’ rights following a foreclosure sale. Read on to learn more.
When purchasing a home, the borrower typically signs two significant documents: a promissory note and a mortgage (or a deed of trust). The promissory note is the personal promise to pay back the money borrowed. 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 purchase, the mortgage is recorded first and, in accordance with the first in time, first in right rule, has priority over all subsequently recorded junior mortgage liens, like 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, like those placed on a property for the collection of property taxes, special assessment taxes, homeowners’ association (HOA) or condominium association (COA) assessments, and contractor fees, might have priority over first 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 two loans, consisting of a $400,000 first mortgage and a $100,000 second mortgage loan. You then decide to do some repairs on the home 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:
Now, imagine that while you’re still upgrading on your home, which is now gutted and worth only $425,000, you lose your job and you stop making your mortgage payments. 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 might 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 won't get any money from the foreclosure, and their liens are now worthless. But they can still try to collect the debt from you in other ways. For example, your friend who loaned you money could sue you and then freeze your bank accounts, garnish your wages, or place liens on other property you own.
If you have concerns or questions about any liens attached to your property, consider talking to a real estate attorney. If you're facing a foreclosure and have questions, talk to a foreclosure attorney.