The title status of property is important to real estate purchasers and sellers. In many instances, when there are blemishes on a title, it’s because of one or more liens on the property. Depending on the nature and number of liens, these title issues can greatly complicate a real estate transaction, which makes the assistance of a reputable Houston real estate attorney invaluable.
What is a Clean Title and Why is it Crucial for Real Estate Investors?
If a title is “clear” then it is free from any liens or other claims that would cast doubt on who owns or has interest in the property. Most purchasers prefer a clear or “clean” title for a few reasons, including:
- No additional tax or creditor obligations
- No additional risk of foreclosure or other legal actions
- Lower risk of future claims to the property by unknown third parties
For real estate buyers and sellers, it’s advantageous for a property to be free of any title issues. Sometimes, despite some title issues, a would-be buyer has enough interest in the property and is willing to navigate the title repair process to take sole ownership.
Liens and Lien Priority: Who Gets Paid First?
A single property may have various liens, often in a certain order of priority. The first-in-time, first-in-right rule is used to determine lien priority – the order in which lien holders are paid if the property is ever sold.
There are different types of liens, including tax liens, mortgage liens, mechanic’s liens, judgment liens and more. The first lien levied against a property is often, though not always, the “senior” lien, while those lower in priority are “junior” liens.
Here’s what lien priority may look like for a real estate property:
- Tax liens – Tax liens are placed against a property by a government agency, and they may concern property taxes or income taxes. In either case, tax liens take priority over all other liens, regardless of when they were levied.
- Mortgage liens – When homebuyers take out a mortgage through a lender for the purchase of property, the lender (usually a bank) will place a lien on the home as collateral for facilitating the buying process. Mortgage liens are senior liens and are typically first in priority.
- Junior liens like second mortgages and mechanic’s liens – Junior liens may be second or third liens, levied against the property when taking out a second mortgage, a home equity line of credit (HELOC), or for improvements to a property (a mechanic’s lien). Junior liens are considered riskier because they are paid off last if the property is ever sold or foreclosed on. If the total debts exceed the property’s value, there may not be enough sale proceeds to pay junior lien holders. If that happens, those lien holders receive nothing.
Prior to a real estate transaction, a title search will reveal if there are any liens against the property. This service can be provided by an attorney or a title company.
Leveraging Liens When Buying or Selling Real Estate Properties
When purchasing a property, the buyer assumes responsibility for any liens attached to it. That means the debt attached to those liens is passed to the new owner. For buyers, this obviously represents an undesirable liability, as lien holders may force the sale of a property if debt obligations aren’t met.
Some real estate investors, though, use liens to their advantage when acquiring properties. Here are some examples of how would-be buyers can make liens work for them:
- Forcing a foreclosure sale – Lien owners have the right to force foreclosure procedures should the property owner default on debt payments. This process can take months to complete, and it involves many steps, but it may be necessary if the owner can’t be located or if liens can’t be resolved otherwise.
Following the foreclosure process, the property is put up for bid and sold. If a junior lien holder has the resources, they may purchase the property outright in this way. Based on market data, foreclosed properties typically sell for about 70 percent of their fair market value, so there’s room for a good deal.
- Negotiating with leverage – Once an investor holds a lien, they can negotiate with other lien holders with leverage. For example, if a second lien holder indicates that they may force a foreclosure sale, they can convince third (and fourth, etc.) lien holders to release a lien for less than full payment on the debt. In this way, a junior lien holder can reduce debt liabilities before acquiring the property.
An emerging investment concept is purchasing junior liens, such as underperforming second mortgages. It may seem counterintuitive to do so, as these lien holders are exposed to additional risk, but there are several ways that junior lien holders can recoup their investment. For example:
- Forcing a foreclosure sale – Forcing a sale can work for many second lien holders, as property values have soared in some markets. If the property’s value exceeds the value of the senior lien, the second lien holder stands to profit if the property is sold.
- Servicing debt tied to the lien – Lien owners are debt owners, which means they can modify the debt’s terms as they see fit. For example, they may reduce the debt’s principal, stretch out terms, modify interest rates – anything to ensure the borrower can continue making payments to the lien holder.
- Acquiring debt for pennies on the dollar – Second liens are risky investments, but this risk is priced into the debt’s purchase. It’s possible for investors to acquire junior liens for 10 percent (or less) of the initial debt, so it’s common for investors to purchase many underperforming second liens and sift through them to see which ones may be profitable.
For the original lien owner, selling the debt for pennies often makes sense because it can be costly and time consuming to service debt. Selling off the debt at a deep discount shifts that debt servicing burden to someone else.
It takes experience and skill to make junior liens work as an investment, which is why it’s highly recommended that investors consult with a real estate attorney before moving forward with a transaction. An experienced real estate attorney can help interested investors make intelligent transactional decisions and ensure they aren’t surprised by taxes or other process-related concerns when buying a property.
Liens: Obstacle or Opportunity?
Real estate has long been a profitable option for investors, but the presence of one or more liens can quickly complicate the process. If you’re considering purchasing or selling a property or a lien attached to a property, it’s worth consulting with an expert in the area before moving forward. A real estate lawyer can advise individuals on how to best acquire a property with liens attached, and how to minimize the cost-related impact of those liens.
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