John (not his real name, but we’ll use John for this story) was referred to me by an attorney because he had gotten himself in a bit of a pickle. It seems that John had purchased homes in his local foreclosure auction for incredibly low prices only to find out that the homes were still subject to mortgages. How could this be? Doesn’t foreclosure wipe out subordinate liens?
It’s certainly true that foreclosure does wipe out MOST subordinate liens (liens that come behind a superior lien), but when buying a home at a foreclosure auction, you still have to do some homework to ensure that you are truly getting clear title to the property.
The most common issue that we see is that someone purchases a home through the foreclosure auction only to discover that they foreclosure wasn’t done by the first mortgage holder, but Homeowner’s Association. HOAs, in most states, have more rights than a first mortgage holder does. Particularly in a Lien Theory state, when an HOA is the plaintiff their disputes are usually fast-tracked through the court system more expeditiously than would a lender’s mortgage. In most cases, when you see an incredibly small mortgage with respect to the value of the home, the lien is likely to be an HOA lien. The first mortgage holder still has rights to the property. The investor that purchases the property through the foreclosure of an HOA lien is not liable for the payments to the mortgage holders, but the other mortgage holders still may foreclose on the property.
In rare instances, a second or even third mortgage holder might foreclose on the property. If a borrower isn’t paying their first mortgage, they likely aren’t paying the second mortgage either. The interest and fees to the first mortgage holder make that balance grow pushing the second mortgage holder’s loan-to-value ratio further and the borrower likely isn’t financially able to maintain the home, which drops the home’s value. This likely will make it not worth the second mortgage holder’s legal expenses to initiate a foreclosure process.
Tax liens are also something that don’t get expunged in a foreclosure action. Whether the lien is to the IRS, state, or local taxing authorities, Uncle Sam gets to pretty much jump in front of any lender they want to. It’s not fair, but it’s the world we live in.
Unless you do some due diligence on the title when you purchase a home at foreclosure, you might find yourself in a difficult, subordinate situation. Do yourself a favor and do your homework before you purchase a property at auction.