If a Second Deed of Trust Is Foreclosed on, What Happens to the First Deed of Trust?

According to attorney Michael Murray, the person or entity that purchases the property at a foreclosure sale initiated by the second lienholder takes the property subject to the first lien. “The purchaser may simply be able to pay off the first lien note. However, the lender holding the first deed of trust, or first lien, is not obligated to allow the purchaser to assume the note, so the failure of the original borrower to continue to pay the principal loan would be a default." Thus, the first lienholder can foreclose against the purchaser, which “wipes out the ownership rights of the second lien note.”

Read your deed of trust carefully; the lender may have inserted language in there that clearly says defaulting on any second lien note, resulting in a threat of foreclosure, automatically triggers a default of the first lien. This means the first lienholder can initiate foreclosure proceedings. In that case, the second lienholder would only get any proceeds from the foreclosure sale left over after paying off the first deed of trust. In a depressed market, in which property values have fallen, it’s likely the second lienholder would get nothing from the foreclosure sale and would have to pursue the borrower separately for the amount owed.

Deeds of trust are paid in the order in which they are recorded in the property records. That’s why a mortgage to purchase a property is typically the first lienholder. Any subsequent deeds of trust, or other liens, fall in line based on each recording date. The exception to this is if the property owner has unpaid taxes. All tax liens -- federal and state, as well as property taxes -- typically take priority over other liens or deeds of trust. That means the county tax office, for example, could initiate foreclosure proceedings for unpaid taxes. The property owner has an opportunity to stop the foreclosure proceedings by paying the taxes prior to the sale, in addition to any related costs, such as attorneys’ fees.

States operate under either a judicial or non-judicial foreclosure process. In states that use a judicial foreclosure, the lienholder must get a court order before the foreclosure takes place. Texas, for example, is a non-judicial foreclosure state. As long as the state laws are followed, the lienholder doesn’t need a judge to sign a court order to seek a foreclosure. Depending on which process your state uses, it can alter what happens with each deed of trust tied to the property, so consult with a real estate attorney to explore your options.