Mortgage and lien priority


For the beginner note investor looking into first position notes, lien priority is the most important concept to understand; it determines the priority of all interest holders in the property with respect to collecting their interest. In other words, lien priority determines the order of debt collection against the person or the property. It’s also the first thing we look at when evaluating risk on any note purchase.

If we only refer to mortgages, a secured debt by real estate property, the priority of a mortgage is determined by the recording date of the mortgage. The earlier the recording date of the mortgage, the higher the priority of the mortgage lien against the property. If two mortgages are recorded on the same day, the priority is determined by the earliest instrument number (or book and page of the recording). For example, if the first mortgage was recorded on 01/01/2000 for $10,000 in Book 5, Page 1, and the second mortgage was recorded on 01/01/2010 for $1,000,000 in Book 5, Page 25, the $10,000 mortgage is considered in the first position, and the $1,000,000 mortgage is in the second position.

Of course, this is an unlikely example, but it can happen. This is considered an origination error where the title company who recorded both mortgages committed an error and now you, as an investor, have to resolve this priority error by filing a document called a subordination agreement. This is the only way to make sure the priority of the lien stays with the higher mortgage.

Involuntarily Lien Priority

In some cases, liens are placed against a person or property without approval of the owner/borrower; they’re called involuntary liens. Real Estate Tax liens (the result of unpaid or delinquent taxes) are considered, in most cases, first priority liens that supersede even mortgages. Any municipal lien, city lien, environmental lien or sewer/water/utility lien (in some states) is considered a higher position lien than the mortgage, as well. HOA liens are considered a higher priority lien over the mortgage only in two super lien states (Nevada and Massachusetts). In rare cases, mechanics liens may be a higher priority than the mortgage. The only scenario where a mechanics lien is a higher priority than a mortgage is when the lien states that the materials (goods) delivered to the property arrived earlier than the recording date of the mortgage. The common example is when the property is new construction and the owner is taking out a mortgage on the purchase at the same time as the builder is supposed to release (pay to all contractors) all mechanics liens.

Liens that Cloud the Title
IRS, Department of Justice (DoJ), USA and state tax liens are considered liens that cloud the title. IRS has a 120-day redemption period after the event of the ownership change, which clouds the title for the period of 120 days before an investor can resell the property. State tax liens are typically junior to the mortgage if they’re recorded after the recording date of the mortgage. SBA (Small Business Administration) mortgages in the junior position have a one-year redemption from the event of the change and, for the investor, an SBA mortgage on the title would mean that the property cannot be sold for the period of one year.

A senior position lien assumes a higher lien priority than the subject mortgage. A junior position lien assumes a lower priority than the subject mortgage. Junior liens don’t survive subject mortgage foreclosure, while senior liens do. The main reason lien positioning is important is the direct impact it has on estimating the total cost involved in perfecting a first lien position for first lien note investors. If there is a municipal lien found against the property, in order to get a clear title it must be paid off, as it would survive the foreclosure.

Perfecting a Lien Position
Another term you might hear as you invest is “perfecting lien position.” If you are buying a note and your title search comes back with various senior liens, you can make your subject lien a first lien by paying off those liens or forcing other parties to file satisfactions of senior liens. If this is your course of action, you are perfecting your lien position.