When it comes to real estate investing, understanding lien positions is non-negotiable. Whether you’re purchasing properties, lending money, or taking on creative financing strategies like “subject to,” knowing how liens work can protect your investments. Let’s break down lien positions, how they’re determined, and why they matter so much.
What Is a Lien?
A lien is a legal claim against a property used to secure a debt. If the debt isn’t paid, the lien holder (the lender or creditor) can enforce their claim, potentially resulting in foreclosure. Common types of liens include:
- Mortgage liens: Issued by banks or lenders when financing a home.
- Mechanic’s liens: Placed by contractors or repair professionals when payment for their services is overdue.
- Home Equity Lines of Credit (HELOC): Second loans secured against the equity in a home.
These liens create a hierarchy—or lien position—based on when they were recorded. That hierarchy plays a pivotal role in determining who gets paid in cases of foreclosure.
How Are Lien Positions Determined?
The date the lien is recorded establishes its priority. Think of it as a line: the first one recorded is the first one paid. If multiple liens exist, the primary (or first) lien gets paid before any junior or subordinated liens.
Here’s a simple hierarchy:
- First Position Lien: Recorded first; has the highest priority.
- Second Position Lien: Recorded later; gets repaid only after the first lien is satisfied.
- Subordinate Liens: All liens after the first—third, fourth, etc.—depend on leftover funds.
Why Lien Position Matters
Lien position directly impacts who gets paid. If foreclosure occurs, only creditors higher in the hierarchy get repaid. Subordinate liens may receive nothing, depending on the sale price of the foreclosed property.
For lenders, this impacts the risk level. Second and third-position liens are much riskier since they’re only paid if enough equity remains after the first lien is satisfied. That’s why loans like HELOCs often carry higher interest rates.
Example: Understanding Lien Priority
To make sense of lien positions, consider this timeline:
- January 12: A homeowner takes out a $200,000 mortgage with Bank of America.
- Bank of America records this loan as the first lien.
- February 7: The homeowner hires Joe the Plumber but fails to pay him.
- Joe records a mechanic’s lien for $5,000, placing it in second position.
- March 21: The same homeowner secures a $40,000 HELOC.
- This HELOC falls to third position in the lien hierarchy.
Here’s where lien positions become critical. If the homeowner defaults on the Bank of America mortgage (the first lien), the property may be foreclosed and sold. In this case, proceeds from the foreclosure would go to Bank of America first. If there’s money left over, it would then go to Joe the Plumber. However, if the sale proceeds don’t cover the mortgage, Joe and the HELOC lender are out of luck—they won’t recover anything.
Now imagine the homeowner stops paying Joe the Plumber instead. Joe, as a second-position lien holder, could foreclose. However, even if Joe takes ownership of the property, he’d still need to satisfy Bank of America’s first lien to regain full control of the property. This shows how being in a lower lien position can add significant risk.
The Risk of Subordinate Liens
Subordinate liens, or any lien below the first, come with unique risks. Subordinate lien holders only get paid if primary lien holders are fully satisfied. When a foreclosure occurs, junior lien holders are often wiped out. Because of this, lenders in these positions require higher interest rates to offset their risk.
For example, if a HELOC lender is in the second position and the first mortgage forecloses, there’s no guarantee the HELOC lender recoups their money. That’s why understanding lien positions is critical, whether you’re borrowing or lending.
Can Subordinate Liens Foreclose?
Yes, subordinate lien holders like contractors or HELOC lenders can foreclose. If they foreclose, they take control of the property subject to the upstream liens. Let’s revisit Joe the Plumber’s case:
Joe the Plumber decides to foreclose on the $5,000 lien he has filed. He successfully forecloses and takes ownership of the property. However, the primary mortgage with Bank of America still exists, meaning Joe must satisfy that debt to maintain ownership. He could either:
- Continue making mortgage payments on behalf of the homeowner.
- Pay off the remaining mortgage balance in full.
This level of responsibility shows why subordinate lien foreclosures are rare—they’re risky and expensive for the lien holder.
Lending in a Subordinate Lien Position
Some real estate investors lend money in second or third lien positions as a way to grow their returns. For example, imagine you have $50,000 in a self-directed IRA or 401(k) and want to enter real estate investing. You may lend this money in junior lien positions to fund a rehab project or help catch up on an existing mortgage.
However, this approach isn’t without risk. If the primary lien holder forecloses, your position may be wiped out. That’s why it’s essential to work with seasoned investors who prioritize their lenders and understand how to manage foreclosure risks.
Protecting Yourself as a Subordinate Lender
Before lending money in a second or third lien position, consider these safeguards:
- Research the borrower’s reputation: Work with investors who have a solid track record of protecting their lenders.
- Evaluate the deal structure: Understand the primary lien balance, property value, and borrower’s exit strategy.
- Assess your risk tolerance: Know what you can afford to lose if the first lien forecloses.
- Partner smartly: Look for high-quality investors or professionals who know how to mitigate risk in subordinate liens.
Why Real Estate Investors Must Understand Lien Positions
For real estate investors, lien hierarchy is crucial knowledge. Every deal involving liens carries potential risks and rewards. Whether you’re lending, investing, or purchasing properties, a clear grasp of lien positions can save you from financial losses.
Education is key. Platforms like Propelio Academy provide valuable resources to help investors build confidence in understanding lien positions, foreclosures, and creative financing strategies.
Conclusion
Lien positions may seem complex, but they’re fundamental in real estate. They determine the order of repayment and define the risk for lenders and investors. Whether you’re lending in a subordinate position or buying a property, understanding lien priority protects your investments and guides smarter decisions.
By taking the time to educate yourself and partnering with experienced professionals, you can confidently navigate real estate deals and achieve greater financial success.
