Tax Deeds & Tax Lien Sales Investing – Part 2

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By Tamera Aragon

So here is a quick recap of Part 1 – Tax Deeds & Tax Lien Sales Investing: When homeowners fail to pay real estate (property) taxes, the government has the right to sell their property in a state “tax sale”. In a Tax Lien state, homeowners have an opportunity to pay back the amount owed within a specific time frame even after their property has been “sold” with interest to a real estate investor. Should homeowners miss the payment deadline, the investor becomes owner of the property at a great discount. In a Tax Deed state, investors bid for immediate ownership of a property or are eligible for the deed and ownership of the property after a redemption period passes. In Part 1 – Tax Deeds & Tax Lien Sales Investing I covered the descriptions of the different investing strategies as well as the rewards and the risks investing in tax liens vs. tax deeds.

Tax Deed Investing Process For Real Estate Investors

Now I am going to cover some of the steps you will need to go through as you go through the entire tax deed process and come out a winner with your real estate investment.

Obtain and Review a List

Obtaining a list of the properties that a county is going to auction at the next tax deed sale is the first thing you need to do. You should first of all find a website for the county and see if they have or will publish a list of their tax deed sales on their website.

Sometimes the county will send you a list two weeks prior to the auction for a minimal fee. You will also want to know how often they update the list prior to the auction. If it is possible to obtain this information in person and meet the people at the county office, it is better than by phone. The more people you personally know and the more questions you ask the better off you will be when you really may need help.

Once you obtain a list, they are usually fairly limited on the information they give about the property. Usually it lists Parcel number, name of owner, address of owner or property sometime both, amount of taxes owing.

You will also want to find out:

  • Date of next auction?
  • When and how do they publish the list and how you may obtain a copy? (Often they are required by state law to publish the list in a local newspaper by a certain date. Usually newspaper will have a copy or it is available online.)
  • What is the actual auction and bidding format?
  • Do they require bidders to register before the auction?
  • What is the registration process for bidders?
  • How your tax deed will be paid for at the end of the auction?
  • How the auction is conducted and rules about bidding?

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Initial List Screening

Most lists will have more properties than you can possibly research. You need to screen the list for the types of properties that you are interested in. Usually there is a code number, the county staff can explain to you, that indicates if a property is a single family home, a developed lot, commercial, residential, duplex, apartment, etc. This is the first step in screening the kind of properties that you have decided you are interested in.

Second is to find the properties that are in the part of the town you may have determined you are interested in.

Third you can screen by the value of the property and the amount you are willing to bid.

Most of this initial screening can be done from a basic list.

Additional information that you want to obtain about the property include what type of improvements are on the property i.e. building, utilities, landscaping, curb and gutters, etc. or is it just land. Also find out the assessor value for both the land and improvements. Take note of the taxes due and when they were last paid. If there is a house or any type of building on the property find out the size, year built, number and type or rooms and if possible find about any other special features the structure may have. Learn additional information about the neighborhood by looking at the houses next door or across the street and maybe even talking to neighbors.

With all of the above information you can narrow your list down to the few properties that you need to drive buy and check out.

Visit the Property

If at all possible, a personal visit to the property is essential. If you can’t do that, a visit via the internet, through different search sites is the next best thing. However nothing tells the whole truth better than visiting the property. What seems like a very nice house could turn out to be next to a crack house or a busy grocery store or on a very busy street. What sounds like a normal building lot may have a beautiful view. You need to screen your list down to a number of properties that you can take the time to go see, especially with tax deed sales.

To save time and money you need to organize on a map your drive-bys so that you can find and record information about the properties in a timely manner. There are many mapping programs available on the internet that you can put the address in, and they will automatically give you a route. When you drive by, the number one thing is to take a picture of the property for your files. You want to write down identifying features found in the picture in case you get them mixed up. You want to rate the house, note any problems and repairs that are needed and rate the neighborhood. Usually unless the property is vacant you should not approach the house or talk to anyone about it.

Some quick things to take note of are as follows:

  • Paint and roof condition
  • Broken windows, doors, cement
  • Underground or overhead utilities
  • Trees, shrubs, general landscaping
  • Condition of adjacent properties
  • Property accessibility
  • Discolored soil or dead vegetation
  • Traffic on the street
  • House vacant, lived in, for sale sign

Make sure to drive around the area looking for any industry or business that would distract from the desirability of the property. Also look for similar properties in the neighborhood that may be for sale and call the owner or real estate agent to find out the price and condition as a comparison for properties value. You can print out this checklist on a spreadsheet that you can fill out while you are in the neighborhood and attach the picture of the property too.

Once you have accomplished all of this research, you are now ready to narrow your list, to the final properties that you will bid for at the tax deed auction.

Check for Recorded Problems

Now is the time to return to the county offices. Go to the county clerk’s office to check if there are any liens on the few properties you now have on your list. Some counties make this process very easy by having the information available online once you have the parcel numbers and address of the property. If there are liens on the property make sure you get the name and contact information on the business of person placing the liens. You need to also check for mandatory deed restrictions on the property. In other words, find out what you can or can’t do or build on the property. You should also check for any government assessment that may be filed against the property.

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The last thing you need to check, as close to the actual auction as possible, is to see if there were any last-minute redemptions by homeowners that would have removed the property from the auction table. One of the most frustrating things about tax deed auctions is the fact that many people don’t want to lose their property and will somehow pay their taxes at the very last moment.

It is not uncommon for a tax deed sale to have 40 to 50 percent of the properties redeem at the last minute. We therefore recommend that you research twice as many properties as you think you can afford to buy because half of them may be redeemed the last day or hour before the auction takes place.

Attend the Auction

The basic work is now over the fun and hopefully reward begins. Go to the auction with a very specific plan and stick to your plan.

Usually, you should arrive about 30 minutes before the auction begins, so that you can register, check the final list that will be there for any last-minute redemptions of your properties, find a good seat where you can see what is happening and review the written or oral instructions that will be given. You may be surprised that there will probably be many people at the auction. Only half of them will actually bid while the rest of the people just come to watch.

There are many types of people at the auction who you will be able to quickly identify. The professional investors who have deep pockets and usually win whatever bid they participate in. The local investors who know the area and the properties around their home or offices and understand value, they are important to watch. The beginners who have no idea what is going on and of course YOU. At this point just smile, stick to your plan and bid amounts. Do not get emotionally involved with the bidding.

Purchasing and Maintaining Your Deed

If you are a successful bidder on a deed, you will need to be prepared to pay the full bid amount plus any fees and outstanding taxes. In some state or counties, you will only be required to pay a deposit of perhaps 10% with the balance due in 30 days. You need to make sure that you have talked with the county official before the sale and know what the payment policy and procedures are if you are successful in obtaining a deed.

In some counties, the owner can still redeem the property within a year after the deed sale. Most states and counties, of course, recommend that no major expenditure and improvement be done during this waiting period in case the sale is over turned. However, this does not prevent you from using the property, renting the property, leasing the property with an option to buy, or using the property for financing purposes.

It is always best to consult with a local real estate attorney about any legal strategies you may have prior to final settlement. Whatever you do make sure that you place liability and fire insurance on the property as soon as the auction is complete. If something happens you will be liable and no one will overturn the sale at that time.

Selling the Property

Now it is up to you, your family, and your real estate agent as to how you profit from this real estate investment adventure once you have the finalized deed. The bottom line is profits no matter what strategy you follow. This concludes my article on Investing in Tax Deeds and Tax Lien Sales from a real estate investor’s prospective.

Tamera Aragon

Tamera Aragon is a professional online entrepreneur and has bought and sold over 300 properties, establishing her as an expert in the real estate investing field. Since 2003, she has purchased over 10 million dollars in real estate and currently holds properties all over the world. Tamera’s focus is on the booming Foreclosure market, buying Pre-foreclosures, REOs and Short Sales. Tamera who is a noted Author, Success Trainer, Speaker & Coach, shows her passion for helping others with the 17 websites she has created and several specialized products to support fellow investors throughout the world. When Tamara is not busy running her website, she is very involved with her Fiji joint ventures and investments. Tamera Aragon is one of the few trainers and coaches who is really “doing it” successfully in today’s market. Tamera’s experience has earned her a solid reputation in the industry as well as the respect and friendship of many of the top national real estate investment and internet marketing experts. Tamera Aragon believes her success has garnered her the financial freedom to fully enjoy her marriage and spend quality time with her children.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Tax Deeds & Tax Lien Sales Investing – Part 1

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By Tamera Aragon

When homeowners fail to pay real estate (property) taxes, the government has the right to sell their property in a state “tax sale”. In a Tax Lien state, homeowners have an opportunity to pay back the amount owed within a specific time frame even after their property has been “sold” to an investor. The investor may be paid back with interest. Should homeowners miss the pay deadline, the investor becomes owner of the property at great savings. In a Tax Deed state, investors bid for immediate ownership of a property or are eligible for the deed and ownership of the property after a redemption period passes.

By law, Tax Deed sales must be announced to the public, and are usually sold to the highest bidder. The winning bidder purchases the deed to a piece of property, becoming the new owner and obtaining all rights to the property – clear of any mortgages, liens, deeds of trust, etc.

One interesting thing to note is very few people know much about Tax Deed sales. So, competition may not be as fierce in this niche as it is in others.

Why Is Tax Lien & Deeds a Good Investing Niche to Consider?

  1. Tax Deeds are sold in almost every state throughout the United States. 50 states are governed by state-mandated laws to protect & reward investors.
  2. You can pick Your Price. Research the list and pick ones out that are in your price range.
  3. You can obtain properties which allow for all types of exit strategies (flip, rent, or live).
  4. Investors & Banks have been using this strategy for over 150 years.
  5. The rules vary from state to state. In certain circumstances you can obtain an entire property for only the taxes and penalties owed. Generally, you will pay between 50 to 90 percent below market price.

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General Downsides of Investing in Tax Lien & Deeds Niche?

  1. Lacking Liquidity of Funds: In a Tax Deed transaction, you can have your money tied up for several years before you can sell the property, because title companies may not issue title insurance on the property until all liens are cleared, and it is obvious that clear title can be granted. This process will sometimes take more than a year. Fixing up and or remodeling properties to maximize your eventually sale can also take considerable time.
  2. Time and Complexity: Tax Deed laws vary from state to state and sometimes from county to county within a state. This requires a time commitment to learn the rules of a state and its counties, research properties and attend auctions. In addition title companies sometimes will not issue title insurance for at least the first year on any property bought at a Tax Deed sale. This means it could be hard to get a loan until it is clear.

Investing Risk: Purchasing property at a Tax Deed sale definitely has risks if you have not done extensive due diligence. You must do your homework, title searches, drive buy inspections, history reports etc. Once you buy a Tax Deed, you will own the property including all of it potential problems. The major thing to keep in mind is that at a Tax Deed sale, unlike a Tax Lien sale, you are buying the real estate and we believe that the required level of due diligence becomes extremely high. The other thing you want to know at a Tax Deed sale is if the property is being purchased free of all other liens and encumbrances. There are a number of states where this is true and a few where it is not true. You need to make sure that you get what you paid for. This requires knowledge of what the values are and what the potential hazard could be.

In summary, Real Estate tax sale laws vary from state to state, as do the redemption periods, and there are risks investors should be aware of in addition to the potential rewards of buying tax sale properties.

Pros and Cons of Tax Lien & Tax Deed Sales

TAX LIENS: A lien is a financial claim made against a property. A Tax Lien is a claim for unpaid property taxes issued by the local taxing authority. Failure to pay real estate taxes is one of the leading causes of distressed properties leading to home loss. Investors typically buy Tax Lien properties through an auction after a homeowner fails to heed warnings by the tax authority to pay property taxes. Most states allow homeowners to reclaim their property by paying off the debt in full by a certain date. This is called the “Redemption Period”. The redemption period offered varies from state to state. However, in some locations, investors may have to wait two full years before being paid back or gaining the deed for the property.

Tax Lien Pros

  • Possibility of good returns in interest (up to 24 percent in some states) paid by homeowners.
  • Possibility of owning property at a fraction of its true value.
  • Option to sell, rent or hold the property for additional profit once title is held.
  • Lower Investment Risk: If the homeowner doesn’t pay up, the tax purchaser is first in line to own the property. No tenants, banks or brokers to deal with.

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Tax Lien Cons

  • May Not Make Any Money: There is no guarantee the homeowner will pay off taxes and interest on the lien. The process of getting the deed at the end of the redemption period isn’t simple and may require a lawyer.
  • Required Capital: You must pay what is typically a large amount of cash for your bid at the tax sale. You definitely will need more capital to buy properties at Tax Deed sales. Although it varies from property to property, from county to county, and even from state to state, you will likely need a minimum of $5,000 to $10,000 to get started in Tax Deed investing. A good credit rating may also be necessary to sign finance contracts. Check local rules and regulation as well as the history of Tax Deed auctions in an area to get a feel for the capital you may need.
  • Uncertainty of property condition: With no prior home inspection, there is no guarantee of the property’s condition or value.
  • Property Owner may Be Foreclosed on: If you foreclose, you are stuck with the hassle of selling the property from which you may profit but on the other hand you may not recoup your initial investment.

TAX DEEDS: A Tax Deed is a legal document indicating ownership of property, also referred to as “title.”When the government intervenes to put properties delinquent in real estate tax payments up for auction, investors can pay the back taxes and own the property for well below market value. To locate and invest in Tax Deed sales, check local newspapers, local tax collectors or the Internet, where many websites post relevant information.

Tax Deed Pros

  • Quick and easier way to become a property owner.
  • Opportunity to acquire existing equity.
  • Opportunity to purchase property directly from the property owner at bargain-basement prices prior to a Tax Deed sale.

Fortunately, investors who sow the seeds of diligent research can reap the rich rewards of tax property sales. DUE DILIGENCE is required for Tax Lien and Tax Deed investing deals. This concludes my article on Investing in Tax Deeds and Tax Lien Sales – PART 1.

Please watch for my next investing article that will wrap up all you need to know to start investing in Tax Deeds and Tax Lien Sales – PART 2. I’ll be going over the steps real estate investors should take for Tax Lien and Tax Deed Investing deals.

Tamera Aragon

Tamera Aragon is a professional online entrepreneur and has bought and sold over 300 properties, establishing her as an expert in the real estate investing field. Since 2003, she has purchased over 10 million dollars in real estate and currently holds properties all over the world. Tamera’s focus is on the booming Foreclosure market, buying Pre-foreclosures, REOs and Short Sales. Tamera who is a noted Author, Success Trainer, Speaker & Coach, shows her passion for helping others with the 17 websites she has created and several specialized products to support fellow investors throughout the world. When Tamara is not busy running her website, she is very involved with her Fiji joint ventures and investments. Tamera Aragon is one of the few trainers and coaches who is really “doing it” successfully in today’s market. Tamera’s experience has earned her a solid reputation in the industry as well as the respect and friendship of many of the top national real estate investment and internet marketing experts. Tamera Aragon believes her success has garnered her the financial freedom to fully enjoy her marriage and spend quality time with her children.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411Expo.com or our Eventbrite landing page, CLICK HERE.

Junior Liens Who Choose to Foreclose

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By Edward Brown

Many lenders opt to only fund first mortgages because they believe that second mortgages are too risky, but is that always the case? Not always. Not all second mortgages are equal.

Many private lenders may choose to fund a junior lien where the first mortgage is relatively small in comparison to the second. For example, a $200,000 second behind a first of only $40,000 on a property worth $500,000 would be an attractive loan to fund for many lenders, especially if they can command a higher interest rate due to the fact that the loan is in second position. However, if there is a foreclosure in the future, the second will somehow have to deal with the first mortgage. This can be troublesome if the first is very large; especially if the second is relatively small in comparison to the first. Why?

In looking at a foreclosure, a lender has to strategize. In the case of the second mortgage, it is imperative that the first does not foreclose out the second as there is usually nothing left over from the foreclosure to pay the second. In California, the foreclosing party gets to “credit bid” its loan. This means that it can simply bid [at the auction/trustee sale] what it is owed. Non foreclosing parties need to come up with cashier’s checks in order to bid. This can be a potential hardship for the second mortgage if the first is the foreclosing party.

For example, if we look at a situation where the property has a value of $1,400,000, the first is $800,000 and the second is $200,000 and the first is the foreclosing party, the first would most likely credit bid its entire $800,000 [it does have the right to bid less than what it is owed, but, if the value is reasonably higher than what is owed to the first, it will normally credit bid what it is entirely owed. The times where the lender bids lower than its entire principal balance is when the lender does not want to own the property and is willing to take a loss just to get the loan off of its books, or the value of the property does not substantially exceed the balance of the first mortgage].

Any bidder at the auction/trustee sale would need to come up with $800,000 at the auction itself or more should any bid exceed $800,000 if the bidder wants to be the highest bidder. In this instance [where the first mortgage is the foreclosing party], the second is not allowed to credit bid its $200,000 balance. It would need to come up with the $800,000 to pay off the first and its $200,000 second mortgage in order to be made whole. True, the second would just get its $200,000 back because that is what it is owed, but, unfortunately, in this case, since it was not the foreclosing party, it has to come up with cash just as any other bidder. Only the foreclosing party is allowed to credit bid.

For this reason, it is important for the second to have a strategy in place. The second wants to be the foreclosing party in most instances, driving the bus, so to speak. Borrowers usually go into default for two main reasons. First, they stop making payments to the lender. Second, the lender’s loan is due, and the borrower has not refinanced or sold the property. In the case where payments have not been paid, junior lien holders have the right to “cure” the first. One can usually do that simply by making the payments to the first. Since foreclosure in California normally takes three months and 21 days, one strategy is for the second to cure the first and start its own foreclosure.

However, this may be cost prohibitive, especially if the first is large and the arrearages on the first are a few months. When the first files for foreclosure, junior lien holders are to be notified. This gives them notice, so they can have the opportunity to cure the first. The second then files its own foreclosure [either because the borrower has probably also not made payments to the second mortgage or because most loan documents state that if a borrower is in default on any mortgage associated with the property, its loan is also in default whether or not the borrower has kept the second current with payments].

One strategy for the second lien holder is to cure the first as soon as possible to allow the second to be the foreclosing party. That way, the second would be allowed to credit bid its loan, but would not eliminate the first; it would have to take the property subject to the first and have to deal with them post foreclosure. However, what happens in the case where the second pays just enough to get the first to stop its foreclosure for the time being, the second starts its own foreclosure, and then does not any more payments to the first and allow the first to start its own foreclosure?

Let’s look at an example and see how this might play out; in our previous example, the property was worth $1,400,000, the first was $800,000, and the second was $200,000. Let’s presume that the borrower stopped making payments on both the first and second mortgages. Both loans have a maturity date five years in the future. If the first files foreclosure, the second could cure the first by making only one mortgage payment to them. Now it is true that most lenders will not immediately file a notice of default after 30 days, but the point here is for the second to make the first mortgage cancel or delay [even temporarily] its foreclosure, so the second mortgage can start its own foreclosure for two main reasons; it puts the second in a situation where in the first does not foreclose out the second, and it allows the second to credit bid its loan at the time of the trustee sale.

Now it is true that, if the second does not make any more payments to the first [other than the one to get the first to stop its foreclosure], the first may start a foreclosure again, but, the first’s foreclosure will be after the second mortgage has completed its foreclosure, buying time for the second to deal with the first [or sell or refinance the property] if the second is ultimately the high bidder at auction. If another bidder outbids the second, the first would get paid, the second would get paid, and the owner [borrower who defaulted] would pocket the difference.

If there is enough equity in the property, either the property will receive a high enough bid to pay off all of the liens, or the second [the foreclosing party in our example] should be able to flip the property fairly quickly or decide to keep the property, as they would be the new owner. If they choose not sell the property, they should very quickly discuss with the first some sort of agreement to either refinance [a new loan to the second who is now the owner] or make payments for a period that will allow time for a new lender. The above information is for discussion purposes only and, as always, one is advised to discuss real estate related issues with a qualified real estate attorney prior to any legal action.

Edward Brown

Edward Brown currently hosts two radio shows, The Best of Investing and Sports Econ 101. He is also in the Investor Relations department for Pacific Private Money, a private real estate lending company. Edward has published many articles in various financial magazines as well as been an expert on CNN, in addition to appearing as an expert witness and consultant in cases involving investments and analysis of financial statements and tax returns.

Why Banks Do Not Allow Junior Liens

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By Edward Brown

Ever wonder why bank’s voluminous real estate loan documents usually include a covenant that the borrower has to accept which prohibits junior [or secondary financing]? Most of the time, these covenants don’t even have language that allows for secondary financing with lender approval. They merely state that no junior liens are allowed. In fact, the language is strong enough to imply that placing a junior lien behind the bank’s 1st mortgage constitutes a default [most likely a curable one] {curable defaults are ones that can be remedied, such as placing insurance on the property if the current insurance expires or is cancelled, as compared to incurable defaults which cannot be remedied (or, undone) such as the borrower filing a Chapter 7 bankruptcy}. Placing a junior lien behind the bank’s 1st mortgage is usually curable if the junior lien can be re-conveyed and the property is put back in the same condition [title wise, that is] as it was at the time the bank made its 1st mortgage.

One might ponder why banks are so strict about not allowing junior liens. After all, a junior lien is behind the 1st mortgage. In fact, some non-bank lenders actually prefer subordinate financing because it is as though there is additional security – another party has an interest to protect; however, traditional banks do not view it in the same way. There are a few reasons for this. First, banks have strict underwriting guidelines wherein they look at the DSCR [Debt Service Coverage Ratio]. The DSCR is a ratio that analyzes the cash flow after normal expenses compared to the monthly requirement for the loan in question [both principal and interest]. Many banks have changed their DSCR ratio requirement, since The Great Recession, from 1.1 to 1.35. This can place a tremendous burden on the borrower to have to come up with a larger down payment, in most cases, thereby requesting a lower loan request by the bank, which, in turn, produces a lower monthly loan payment. Many borrowers find that they have to come up with upwards of a 35% down payment as compared to 25% [pre Great Recession] in order to satisfy the 1.35 DSCR. Adding junior liens may place the borrower in the default provision of the DSCR if the junior lien requires monthly payments.

Another point to consider is that the bank priced its loan based upon original underwriting guidelines and being the only mortgage and that no junior financing would be added. The potential risk of negative changes in the DSCR or possibility that the borrower stripped equity away by placing a 2nd mortgage had not been considered, and the bank was not compensated accordingly. The more debt on a property, the more likely there is for a chance of foreclosure. Although the bank may be protected in its 1st position [presuming that the property has not substantially declined], when a foreclosure is triggered, there is a strong likelihood that the bank may have to alter the asset class of the property from performing to non-performing or it may be categorized as a “troubled asset” or put on the “watch list” by regulatory bodies even if the bank is not at risk for losing money. For example, if the borrower put 35% down on a $1,000,000 building and borrower $650,000 from the bank, the bank’s 65% LTV loan may be considered conservative. However, if the borrower obtained a 2nd mortgage for 15% LTV, the property now is 80% leveraged. If the borrower defaults on paying on the 2nd, he may or may not default on paying on the 1st. If the borrower defaults on both the 1st and 2nd, the bank’s loan clearly has turned non-performing. Non-performing loans can have a devastating effect on a bank, as they are required to set aside reserves, and defaults exacerbate this situation. The more reserves required to be set aside means the less money the bank has to lend out and generate income. Since banks lend out in multiples of their deposits, any money that is set aside [that cannot be lent out] has a negative multiplier effect.

The 2nd may or may not cure the 1st and start its own foreclosure. Even if the 2nd cures the 1st, the bank is still left with a possible foreclosing party [the 2nd]. When banks make loans, they are usually looking/hoping for those loans to continue until maturity. Once a loan is made, there is less work the bank has to do. They collect the interest income and hope they do not have to use other resources to babysit a loan. The cost of these resources tax the bank’s bottom line. Banks are not in the business of taking over borrower’s properties. They do not want REO’s [Real Estate Owned properties]. It is much better for them to carefully underwrite loans in the beginning and avoid problems. If the 2nd ends up with the property because nobody outbid the 2nd at the foreclosure, the bank is faced with a new borrower. The bank may have to underwrite the new borrower. In fact, if the 2nd is outbid at foreclosure, the bank is still faced with a different borrower than they originally underwrote. This new borrower may or may not qualify under the bank’s lending guidelines.

What about the scenario wherein the borrower borrows on a separate property and cross-collateralizes against the bank’s subject property? In this situation, the borrower is not attempting to strip out equity from the original property. The borrower may just be faced with the reality that he cannot obtain a loan for the target property unless he is willing to allow the new lender [on property two] to place this same loan on property one for added security.  Unfortunately, although this seems innocent enough, if the bank finds out that a junior lien was placed on the property, [original one] they still may consider their loan in default. A lender who cross-collateralizes against other properties may trigger a foreclosure on all properties they encumber in order to get the borrower to move toward a solution to satisfy their loan that is in default [under their terms…usually for non-payment of mortgage payments].

Public policy may state that a bank is not allowed to interfere with a borrower’s business and force him not to purchase/borrow on other property that the bank has no involvement. There also may be a question as to the validity of the “no junior liens allowed” as this may technically interfere with the borrower’s business, especially if the bank’s 1st mortgage is extremely low. For example, if the 1st mortgage only has a balance of 20% [either because the borrow put a substantial amount down or the 1st loan is so seasoned, that it has been amortized down to a low balance], there is very little risk of the bank not getting paid in full. Even if a 2nd is placed upon the property, one has to question how the bank is impeded should the 2nd start a foreclosure. In previous scenarios above wherein the DSCR was negatively altered due to a 2nd mortgage, a 20% LTV on the 1st should still satisfy a 1.35 DSCR in most circumstances. After the 2nd obtains the property [or a new owner should the property end up in a higher bidder’s hands], most new borrower’s would hopefully be qualified to service a low LTV. Of course, each circumstance is independent, and most banks will want to preserve their right to enforce the “no junior lien” clause.

Usually, only if the bank pulls a preliminary title report, are they aware of the junior lien. They are not usually automatically notified. The main question is whether the bank will automatically declare a default if a 2nd is placed on the property behind their 1st? When banks find out that a 2nd exists, they may either ignore it or send a letter requesting/demanding that the junior lien be removed as per the terms of the bank’s loan documents. Whether a bank decides to pursue its demand that the junior lien be removed is up to the bank; however, they want to preserve their rights by notifying the borrower that they have requested removal, and thus, have written evidence that they contacted the borrower, so the borrower cannot claim ignorance or non-notification of the break in the covenant of the bank terms. This notification protects the bank should the bank choose to start its own foreclosure due to the default.

Most borrowers who have asked permission for a junior lien to be placed behind the bank’s 1st mortgage have usually been told, “No”. That is why most borrowers figure it is better to ask for forgiveness than permission in hopes that the bank will not find out about the junior lien until the borrower either sells or refinances the property in question.

 

Edward Brown

Edward Brown currently hosts two radio shows, The Best of Investing and Sports Econ 101. He is also in the Investor Relations department for Pacific Private Money, a private real estate lending company. Edward has published many articles in various financial magazines as well as been an expert on CNN, in addition to appearing as an expert witness and consultant in cases involving investments and analysis of financial statements and tax returns.

Liens and Encumbrances Affecting Real Property

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By Dan Harkey

What is a Lien?

A lien is a legal right, usually referred to as a security interest, in real or personal property given to a creditor to hold and possess as consideration for a loan. The creditor /lender has a charging interest against the collateral and may seek possession in the event of default by the borrower. A borrower willfully grants the security interest in a real property by agreeing to sign instruments called a deed of trust or mortgage which are recorded in public records as an encumbrance to the real property in consideration for the loan. A lien refers to a monetary claim which may be attached to one or more properties.

What is an Encumbrance?

An encumbrance refers to a claim and/or agreement to enforce the rights and obligations relating to a property. There are literally dozens of items that may be recorded in public records that create either a lien or an encumbrance on the property. The first will be the original tract map. Then comes utility easements, other easements, government mandated requirements such as historical registries, association by-laws, ownership and partnership agreements leases; various public notices such as notice of weed abatement, notices of substandard condition, lis pendens, property settlements, divorce decrees, subordination, non-disturbance and attornment agreement (commonly abbreviated as an “SNDA agreement”) parking easements, reciprocal usage and parking agreements, signage easements, property tax, federal or state tax liens. etc.

The lending industry sometimes uses the terms lien and encumbrance interchangeably. However, a lien is a monetary charge against the property. All liens are encumbrances, but not all encumbrances are liens. They both create a claim against the property that impacts the transferability and restricts the free use until the claim is lifted or is conveyed.

How does an attachment to a property occur?

In the United States we have a government system referred to as the municipal recorder’s office. The recorder’s office has the task of maintaining public records, documents; and in this case, relating to real estate ownership. Additionally, their task includes recording and maintaining records, making those records available and identifiable to the public. Those public records can relate to both voluntary and involuntary rights and claims.

Each of the above creates a cloud on title that must be dealt with, either accepting to property with the conditions or clouds, removing from title, releasing, modifying, or rejecting the property because the risk of accepting all the conditions is go great or not practical.

Each document that is recorded on the property may also contains an agreement, considerations, prohibitions, and risk that must be dealt with.  A recorded trust deed may have 20-40 pages of legalese that need to be reviewed.  The document may contain clauses such as “due-on-sale”, “due-on-further encumbrance,” etc.  This subject relating to clauses in loan documents should be addressed in another article, because of its tremendous complexity.

Sometimes a property owner may record changes in amends ownership status.  An example would be changing or conveying the title of a property from “husband and wife as joint tenants” to a “revocable family trust”. Another example may be the recording of a divorce decree or a quit claim relinquishing one’s interest in the property.

This body of knowledge and law and the process of recording and maintaining the documents becomes very important when establishing the priority of a lien or encumbrance. California law regards lien priority as “first-in-time, first-in- right”.

What is a first, second and third lien priority?

Lien priority is related to the point of time that the document is recorded in the public records office.  When a document is recorded it is date stamped and given a sequential recording reference number.  If a borrower or his/her title company recorded 3 liens at the same time on one property, that would create a first, second, and third lien, regardless of the dollar amount of each lien. The first lien is considered a senior lien, the second and third liens are junior liens. with the second lien being senior to the third.  After the documents are recorded and scanned into the public records computers the borrower will receive the original documents back for safe keeping.

What insures the order of the recording.  How do you know that the recorder did not make a mistake and record the documents out of order?  You may order and pay for an insurance policy referred to as title insurance from a title insurance carrier. The policy guarantee’s your lien priority position or may be required to pay insured claim.   If you were to go to the recorder’s office yourself, stand in line, and have the documents recorded you could check the sequence of recording yourself.  But, generally your recording of documents is done by a title company in relation to a sale or loan transaction in which you are a principal party.

Let’s assume that there was a first lien of $100,000, a second lien of $50,000, and a third lien of $25,000. on a property that you own.  If you paid off the first lien, the second would become a first lien, and the third would become a second lien. If you were to refinance and consolidate all three liens, then all three liens would be reconveyed and removed off public records. A new recording, with a fresh date stamp and recording number would be placed on public records reflecting a new first lien position. A reconveyance is a written form instructing the recorder to remove and release the lien from public records.

There are written agreements that can be created by principal parties that modify the priority of a lien, or multiple liens. One is called a subordination agreement that can be recorded that may make a lien junior to another lien even though it was recorded earlier with an earlier date stamp.

California law regards lien priority as “first-in-time, first-in- right”. California law also provides for exceptions for some types of liens whereby some liens are given “skipping power” to the front of the line. Government mandate permits certain liens to be advanced so that they become senior in priority to other liens. Mechanic’s liens, meant to ensure that tradesmen and contractors are paid, is an example of a priority lien with “skipping power”. That right is protected by the California Constitution, and further enumerated in the California Civil Code (Section 3110 et seq.)

There are limits, however, on the “skipping power” of mechanic’s liens. These relate to technical requirements such as when the construction began and the process that the claimant must follow to enforce that lien. Even in situations where the mechanic’s lien appears to have been “wiped out” by a senior lien holder at a foreclosure sale, the lien is not automatically expunged. For more specific requirements for mechanic’s liens the lender should work with counsel knowledgeable about construction law and mechanics lien law.

Other exceptions relating to “skipping power” may include issues relating to property taxes, special tax assessment districts, and in some cases homeowner’s or mutual property associations.

As a rule, a written tenancy agreement has “first-in-time, first-in right” priority. Tenants who have written agreements with dates prior to the recording of a new trust deed will have a right of occupancy and enforcement that is senior to the new lien. The tenant’s rights will run with the property until the rights expire or are modified in writing.

A real estate lender may require some modification of the statutory priority by using a written agreement between the borrower, the tenant, and of course, the lender. There are times where it may be in the lender’s best interest not to preserve the tenancy in which case a straight subordination may be used. Any change in the chain of title, whether it is a sale, a new loan or a foreclosure, can cause the priority of tenancy to be lost.

In some cases, the lender may wish to preserve the tenancy of credit tenants in order to preserve the value of the property. A subordination, non-disturbance and attornment agreement (“SNDA agreement”) may be the appropriate document to have recorded. SDNAs are agreements between a tenant and a landlord that lays our certain rights of the tenant, the landlord, and other third parties, such as the landlord’s lender or a purchaser of the property.

If I can answer questions or I refer you to good service providers, I am only a phone call away. Please visit my web site www.danharkey.com to read more of my articles related business, real estate finance, and humor & prospective.

Thank You!

Dan Harkey

Business and Private Money Finance Consultant

Bus. 949 521 7115

Cell 949 533 8315

The article is for educational purposes only and is not intended as a solicitation