When buying any kind of property, especially a home, buyers need to be aware of the potential problems that may arise if prior liens aren’t satisfied before taking ownership. For those looking to get into the real estate investing game by buying properties at foreclosure sales, paying close attention to and understanding the different types of liens that could affect the property will be the surest route to success.
What is a lien?
A lien is non-possessory security interest on a piece of property. There can be several different kinds of liens placed on a property, each indicating the entity or individual with the interest. In some cases, they have the legal right to sell your property in order to recoup the debt or foreclose on you.
Some common types of liens found on properties:
- Mortgage lien
- Mechanic’s lien
- Tax lien
- Municipal lien
How long will a lien on your property last?
For the most part, these liens will remain as a “cloud” on the title of the property until they are paid and properly cleared by the lien holder. Unlike mortgage, mechanic’s, and tax liens, not all municipal liens that stay with the property are held in the public record. Many municipal departments keep this information in their own records and require special requests to access it. These are called “unrecorded” liens as a result.
Foreclosure doesn’t mean that these liens will be wiped out. In fact, should you buy a property at auction to find later that there is a mortgage, mechanic’s, tax, or municipal lien still attached, you will be responsible and indebted to that party. Those lien holders will be notified when the title is recorded in your name and you’ll be on the hook to pay up.
Usually, if you purchase a foreclosure at auction, you may find the lien holder is willing to reduce or forgive debt left on the property, but that’s not always the case. You may need to hire a representative to help negotiate the lien. In the case of federal tax liens, this may help save you money. You may also find that some of these liens have been satisfied, but the process to remove them wasn’t completed.
In order to get any lien removed from the public record, after meeting the requirements of the lien, a release must be subsequently filed. Without the release, the lien will never go away and a settlement agent may need to be hired to clear or cure the title.
Municipal liens need to be paid off by the current owner before closing if a buyer doesn't want to be responsible for unpaid utility bills, code violations, or open/expired permits. Otherwise, the buyer will be left to payoff the unrecorded liens or work with an attorney to see if the municipality is willing to waive or reduce the lien. Some homebuyers or investors may be willing to incur these liens if they feel the property is an otherwise good investment. In order to reveal any of these issues, a buyer will want to make sure a Municipal Lien Search is conducted.
A mortgage is a lien or security that the lender holds for the lifetime of the loan. Oftentimes, mortgage and loan are used interchangeably. The mortgage itself is not a loan, instead it is interest in the real property to protect the lender should the borrower default on the loan.
The mortgage lien will stay on your property until you pay off your loan or sell the property and use the proceeds to satisfy the remaining balance of the loan.
Title Theory vs. Lien Theory
The interest a lender has on a property can take two forms based on your jurisdiction’s prevailing legal theory. The lender can own the property outright and hold the title, but still allow the homeowner to occupy the residence as if they own it, or the lender can place an “mortgage lien” or encumbrance on the property that must be satisfied before the homeowner can sell the property.
States where lenders hold the title are called “title theory” states while those that require lenders to put a lien on the property in lieu of taking the title are called “lien theory” states.
For title theory jurisdictions, the lender will hold the actual legal title on the property while the borrower will hold the equitable title. During a real estate transaction, the seller actually transfers the property to the lender who subsequently gives equitable title to the borrower.
This makes it much easier for lenders to step in and foreclose on borrowers should they fail to meet the requirements of the loan. In this case, since the lender already owns the property, they simply revoke the equitable title of the borrower and take possession of the home.
On the other hand, in lien theory states, the borrower takes the legal title, but the lender places a lien on the property, creating an encumbrance or “cloud” on the title. Should a borrower decide to sell the property before fulfilling the terms of the loan, this lien will show in title search. As a result, the portion of the sales must satisfy the remaining loan amount before the clouded title is cleared.
Simply paying off the loan will not, however, clear the mortgage lien in the public record. A corresponding release, satisfaction, or reconveyance of deed must be filed with the county clerk's land records.
No, surprisingly, this isn’t related to the automotive industry. A mechanic’s lien is a security interest in the title to real or personal property for the benefit of those who have supplied labor or materials that improve the property. This serves as an effective tool for construction companies and contractors to get paid on time and in full for building projects.
Mechanic’s liens expire but they don’t disappear.
There are mechanic’s lien laws in every state, but the time frame in which this type of lien will expire varies from state to state. For instance, in California, most mechanic’s liens will expire after 90 days from the date it was recorded, but in Florida, the lien will be in effect for a year.
Just like a mortgage, a mechanic’s lien is recorded in the clerk of the court and will remain recorded against the property until the contractor or company that filed it cancels the lien with the clerk.
Expired mechanic’s liens will not disappear from the clerk. It must be cancelled by the contractor or subcontractor when it's paid. Even if the contractor simply decides not to pursue the lien claim, it must be cancelled in order to release the lien on the property.
If this lien is not released by the company or individual who filed it, it will appear as a cloud on the title long after expiration.
As the name suggests, a tax lien is slapped on a property when the owner fails to pay their taxes. There are a few taxing authorities with the right to do this.
- State Income
The federal tax code expressly states the amount of an unpaid federal tax (including any interest, penalty, or additional amounts, or other costs) is “a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.” 26 U.S.C. § 6321.
IRS liens will stay on a property even after foreclosure under certain circumstances. So, buying a home at a foreclosure auction will not extinguish this lien immediately. There is a chance, however, that a buyer may not have to pay up. If the IRS doesn’t exercise its redemption right within 120 days of the a new deed being recorded, it will expire.
For the owner who is responsible for the tax liability, this lien will stay on the property until it has been paid off, the statute of limitations expires (10 years) or the taxpayer meets the requirements for a repayment program.
States will also file a lien on a home for unpaid individual income taxes. How long this lien will stay depends on your state's statutes, which vary greatly.
State child support liens are another type of lien commonly found on a in the public record against the property owner. These are filed on behalf of the payee by the state agency that collects child support. These liens will stay on the property until the payor demonstrates payment and the agency cancels the lien.
Property taxes are collected at the county level. Should an owner fall behind on their property taxes, their property will be liened. After some time, if the owner continues to not pay, the property will be put up for a tax deed sale. This allows investors to purchase tax deeds or certificates by paying the tax debt.
The unpaid property taxes will be satisfied by the sale, but it doesn’t transfer the title of the property to the investor. If the delinquent taxes are paid by the current owner within a certain time frame, the certificate holder is reimbursed the cost of the certificate plus interest and the lien is removed.
If the taxes remain unpaid, the certificate holder can initiate a public auction conducted by the Clerk of the Court to pay the property tax debt and extinguish the lien.
There are many layers to local government, and understanding how a property is affected by them can get confusing. In some cases, a county may assess your property for roads and street lights while the city bills you for water.
In each instance, that entity may have the right to lien on the property instead of the individual account in order to recoup unpaid assessments, bills, and fines. Sometimes this information may be part of the jurisdiction’s tax records or sometimes it may be held within a specific department of the municipality.
Some potential liens to be aware of on the municipal level include:
- Code Enforcement for debris removal or mowing
- Demolition or environmental based liens
- Board of county commissioners for special assessments
- Utility liens
- City liens for road improvements, maintenance, stormwater, etc.
- Water and sewer liens (not applied in every state)
- County or School/Township for unpaid taxes
Every property is different, so it helps to conduct or request a municipal lien search or tax certificate to find out what governing entities have rights to lien on your property depending on what state you live in.
Selling and buying a home with a lien
A lender won't finance a loan for a home with either an IRS, state or property tax or municipal lien on it because the lien currently filed in the public record will take priority over their new lien (the mortgage). Generally, state and municipal liens are superior to federal tax liens, regardless of when the federal tax lien is recorded. Federal tax liens typically take priority over mortgage liens. When one lien takes priority over another, it's called a super priority lien.
These liens will typically stay on the property even after foreclosure, affecting a new homeowner or investor’s interest in the property until it is paid or released by the lien holder.
An owner will have to settle these debts before selling if they want to make their home marketable. Some investors may be willing to buy the house for cash at a discounted price and take on the burden of the lien. It's important for buyers who are new to property auctions to do their research on a property before bidding so they don't get saddled with any surprises. What seems like a great deal, might not be what it seems.
These liens also make it difficult to refinance your home, and they wreak your credit score. The unpaid lien will stay on your credit report for 10 years after it is filed. After paying it off, it may stay on your credit history for up to seven years.
How can homebuyers and real estate investors avoid liens?
The best way is to perform proper real estate due diligence. Beyond assessing the value and condition of a property, you have to consider all the potential negatives that may affect your investment.
There are two ways that homebuyers and investors can protect themselves from these issues:
- Get title insurance
- Get a municipal lien search or Tax Certificate - depending on your region
In most states, if you are purchasing a home with a loan you are required to purchase title insurance for your lender. This policy, however, doesn’t extend to you as the homeowner, so you must buy your own in addition.
Title agents will search for any recorded liens and clear any encumbrances from the title of the property before you buy it. Should a recorded lien or any other issue covered in your policy go undiscovered before closing, the title company and their underwriter will help settle the issue on your behalf.
Municipal Lien Search
A municipal lien search is a report that will show all unrecorded debt held with a municipality like a town, city or county that may eventually turn into a lien. Likewise, a Tax Certificate will show any outstanding money owed for municipal operations like schools, water and sewer, and other assessments.
These reports are important for you to assess the financial health of your property. This report will show you any issues that are often listed as exceptions to a title policy like unpaid utility bills or open and expired permits. These problems are inherited by a new owner and can be costly to remedy.
While the title insurance will cover any previously recorded liens not found before closing, these reports will show anything that could be a potential threat that may not be covered by title insurance due to the “gap period.” This is a time in between which the title search is conducted for the policy issued and the time of or after closing. Should any type of lien be filed after closing, title insurance is limited by the policy written for the specific time before that gap. The municipal lien search report will help prevent any surprise liens from your county, city, or town.