A lien is a legal claim against a property as a result of a debt owed.
By default, a mortgage which is a loan with the house as collateral will result in the lender placing a lien on the property in question.
The most common types of liens include:
- Mechanic’s liens placed by builders and contractors for the improvement of the property
- Mortgage liens placed by lenders for financing the home purchase
- Judgement liens placed by order of the court
- Tax liens placed by IRS for tax obligations
The first two are voluntary liens while the latter two are involuntary liens.
When it’s comes to liens, what’s critical for claimants is the priority in which their liens are placed.
As multiple liens can be placed on a piece of real estate, there must be a system of prioritizing who gets paid first should the property in question be liquidated by force.
The first (senior) lien would have top priority, second (junior) lien holder would be up next, and so on…
This is important for lien holders as it gives them an idea of how likely they are to get their money back should there be a forced sale, maybe via a foreclosure.
For example, if a house is worth $100,000 and a lender has a first lien on it with $70,000 outstanding, a developer might not be willing to take on a $40,000 construction project on the land.
This is because should the house be sold off, the proceeds from the sale would fully pay off the lender’s $70,000 but the remainder of $30,00 would not be able to fully pay off his share.
In the event of this becoming reality due to bannkruptcy, lien-stripping takes place and junior lienholders become unsecured creditors.
The builder will have to weigh up the pros and cons and decide for himself.
This means that a formal request is made to the first lender to move down to second place.
While subordination can be beneficial to the borrower by way of better interest rates and more flexible terms from the second lender, the first lender has little incentive to agree to such requests.
Ultimately, if some form of assurance is given to the first lender, an agreement might come to fruition.
The only way a property can free itself from a lien is to pay off all the debts in which the property secures.