Understanding Mortgage and Lien Priority: A Key Factor in Note Investing

For novice note investors exploring first position notes, grasping the concept of lien priority is paramount. It dictates the pecking order of all parties with interests in a property when it comes to collecting their dues. In simpler terms, lien priority determines the sequence in which debts are settled concerning the property or individual. It’s the first factor we assess when evaluating the risk associated with any note purchase.

When it comes to mortgages, which are secured debts by real estate properties, the priority of a mortgage is primarily determined by its recording date. The earlier a mortgage is recorded, the higher its priority as a lien against the property. In cases where two mortgages are recorded on the same day, the priority is established by the earliest instrument number or, alternatively, the book and page of the recording.

Consider an example where 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. In this scenario, the $10,000 mortgage claims the first position, while the $1,000,000 mortgage is relegated to the second position.

While this may seem like an unusual case, it can indeed happen due to origination errors. In such cases, where the title company that recorded both mortgages made an error, you, as an investor, must rectify this priority issue by filing a document known as a subordination agreement. This is the only way to ensure that the higher mortgage retains its priority status.

Involuntary Lien Priority

There are instances where liens are imposed on a person or property without the owner’s or borrower’s consent. These are referred to as involuntary liens. Real Estate Tax liens, typically resulting from unpaid or delinquent taxes, are often considered first-priority liens, even superseding mortgages in most cases. Additionally, municipal liens, city liens, environmental liens, and sewer/water/utility liens (in certain states) are all deemed higher-priority liens than mortgages. HOA liens take precedence over mortgages only in two super lien states, namely Nevada and Massachusetts. In rare situations, mechanics liens may assume a higher priority than mortgages. This occurs when the lien states that the materials or goods delivered to the property preceded the recording date of the mortgage. A common example is during the construction of a new property, where the owner obtains a mortgage simultaneously with the builder releasing payments to all contractors, thus clearing all mechanics liens.

Liens That Cloud the Title

Certain liens, such as those from the IRS, Department of Justice (DoJ), USA, and state tax authorities, are considered title-clouding liens. The IRS, for instance, imposes a 120-day redemption period following a change in ownership, which clouds the title during this duration before an investor can resell the property. State tax liens, if recorded after the mortgage’s recording date, are usually junior to the mortgage. Small Business Administration (SBA) mortgages, when in a junior position, carry a one-year redemption period from the ownership change event. An SBA mortgage on the title implies that the property cannot be sold for a year.

Understanding lien positioning is crucial because it directly impacts the calculation of the total cost involved in establishing a first lien position for first lien note investors. If a municipal lien is discovered on the property, it must be settled to obtain a clear title, as it would endure even after foreclosure.

Perfecting a Lien Position

Another term you’ll encounter in your investment journey is “perfecting lien position.” If you’re purchasing a note and your title search reveals several senior liens, you can elevate your subject lien to a first lien by clearing those liens or compelling other parties to file satisfactions of senior liens. This process is known as perfecting your lien position, ensuring that your investment is secured and prioritized correctly.