The Impact of Senior Lien Foreclosures on Non-IRS Junior Federal Liens
It is fair to say that most attorneys and title examiners presume that the foreclosure of a senior mortgage will eliminate or “wipe-out” the junior encumbrances of record. This statement, in most cases, is entirely accurate. However, there is a caveat when it comes to federal liens that many may not be aware of. In the past 10 years there has been a significant increase of government-sponsored mortgage modification programs. These are designed to relieve distressed borrowers and the prevalence of partial claim mortgages held by HUD. Therefore, understanding the impact of a foreclosure of a senior encumbrance when these junior liens exist on title is critical.
What Are the New Requirements Relative to Junior Federal Liens in a Foreclosure Context?
A Virtual Underwriter Bulletin set forth mandatory requirements relative to junior federal liens in a foreclosure context. These requirements may be significantly different than what you may have previously done in the context of insuring titles derived from a foreclosure. These new requirements and the underwriting guidance stem from the federal court decision in Show Me State Premium Homes, LLC v. McDonnell, 74 F. 4th 911; 2023 U.S. App. LEXIS 18406 (8th Cir. July 20, 2023) (“Show Me Case”). The Show Me Case highlighted the need to follow federal law, specifically 28 USC § 2410 when title is encumbered by junior federal liens.
Prior to the Show Me Case, underwriting protocols and guidance relative to insuring land subject to a foreclosure where the United States held a junior interest was guided by state law based on the holding in United States v. Brosnan, 363 U.S. 237 (1960). The Brosnan decision provided the support for the underwriting guidance that a foreclosure completed in compliance with state law, would extinguish junior liens held by the federal government. As a result of the Show Me Case, underwriting standards required reevaluation. The results of the reevaluation are captured in Bulletin SLS2024016 (virtualunderwriter.com) – UNDERWRITING – Non-judicial Foreclosures Involving Junior Federal Liens.
How Do Underwriting Changes Affect Foreclosures?
The new underwriting standard set forth in the Bulletin will most immediately impact those jurisdictions where mortgage foreclosures are non-judicial. This is a large group, as non-judicial mortgage foreclosures are permitted in more than 30 states in the U.S. It is important to remember that the Show Me Case didn’t limit the application of 28 USC § 2410 to mortgages or other voluntary liens but applies to lien enforcement where junior liens to the federal government exist; however, mortgage foreclosures are the most seen lien enforcement actions from a title perspective.
The key takeaway from the SLS20240016 Bulletin is that if the search discloses that title was derived from a non-judicial foreclosure and the title was encumbered by a junior lien held by the federal government, which lien is anything other than a federal tax lien, if the foreclosure was conducted via the power of sale contained in the mortgage, the lien of the federal government may not be extinguished and remains a valid encumbrance on the property. As a lien that survives a non-judicial foreclosure, the title remains encumbered by the federal lien post foreclosure. As a result, unless a release or discharge is obtained, a third-party purchaser will be purchasing subject to the lien and any mortgage placed on the property will not take priority over the federal lien.
Review Creditors Now
As mentioned above, given the prevalence of second lien mortgages granted to HUD through various government sponsored mortgage modification programs, it stands to reason that many more homeowners have junior liens held by the federal government through HUD (the Secretary of Housing and Urban Development). Therefore, a careful review of all junior creditors in a non-judicial mortgage foreclosure must be undertaken.
If the title discloses a junior lien held by HUD, and the sale does not produce surplus funds, there exists an opportunity for the foreclosing lender to request a release of the junior mortgage held by HUD from title. The process at present, however, is limited to the foreclosing lender and not subsequent third-party owners and is for a limited group of HUD mortgages. Consequently, this process needs to be pursued prior to the transfer of title to a third-party buyer. HUD’s interim guidance on this process can be viewed here: Interim Procedures for Nonjudicial Foreclosures with Secretary-Held Liens (hud.gov)
Questions About Junior Federal Liens, Foreclosures and Title? Stewart Underwriters Are Here for You.
This is a complex and, at times, confusing area of the law. Stewart’s underwriting team welcomes any questions you may have whenever your title discloses a foreclosure which may be impacted by junior federal liens. Please don’t hesitate to reach out when navigating this area of title law and underwriting requirements.
Reach out to your local Stewart representative for more information. Visit virtualunderwriter.com for up-to-date information on the latest in underwriting.
If you are a Stewart Trusted Provider, feel free to contact your Stewart underwriting counsel with questions.
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