What Happens to the Mortgage in a Tax Lien Sale?

Property taxes are levied by local governments to fund essential services like schools, public safety, and infrastructure. These taxes are typically calculated based on the assessed value of a property and are a recurring obligation for property owners. Failure to pay these taxes can lead to significant consequences, including the imposition of a tax lien. This legal claim against a property serves as security for the unpaid taxes, and its existence can profoundly affect all parties with an interest in the property, including mortgage holders.

Defining Tax Liens and Sales

A tax lien is a legal claim placed on a property by a local government when property taxes become delinquent. This lien acts as an encumbrance, indicating that the property owner owes a specific amount, which includes the unpaid taxes, along with any accrued interest and penalties.

To facilitate the collection of these overdue taxes, governments often conduct tax lien sales, which are typically public auctions. In a tax lien sale, the government does not sell the property itself, but rather the right to collect the delinquent taxes from the property owner. Investors bid on these tax liens, and the winning bidder pays the outstanding tax amount to the local authority. This investor then holds the lien and earns interest on the amount paid until the property owner redeems the lien by paying back the investor.

Understanding Lien Priority and Mortgage Impact

Property tax liens hold a unique position in the hierarchy of claims against a property, known as lien priority. Property tax liens generally hold a “super priority” over most other liens, including mortgages. This means that regardless of when a mortgage was recorded, a property tax lien typically takes precedence, standing as the primary claim that must be satisfied before other debts. This elevated status is granted because property taxes are considered necessary for the functioning of local government.

While a tax lien sale initiates a process that can impact a mortgage, the mortgage itself is not immediately extinguished by the sale of the tax lien. The mortgage remains attached to the property, but its priority is superseded by the tax lien. This subordinate position means that in a scenario where the property ultimately goes to a tax deed sale, the tax lien holder’s claim will be satisfied first from the proceeds, potentially leaving nothing for the mortgage holder. The super priority of tax liens creates risk for mortgage lenders, as their security interest becomes secondary.

Mortgage Holder’s Rights During Redemption

Following a tax lien sale, a defined period known as the “redemption period” begins, during which the property owner or other interested parties, including the mortgage holder, can pay off the outstanding tax lien. This period offers an opportunity to prevent property loss. The length of this redemption period can vary significantly, typically ranging from six months to several years, with common periods being one to three years.

To redeem the property, the mortgage holder must pay the tax lien buyer the amount they initially paid for the lien, along with any accumulated interest and penalties. Interest rates on tax lien certificates vary widely by jurisdiction. Many mortgage lenders actively monitor tax payment statuses for properties they finance and may choose to pay delinquent property taxes themselves to protect their investment. By doing so, the mortgage holder essentially steps into the shoes of the tax lien buyer, adding the amount paid to the existing mortgage balance, thereby preserving their lien against the property.

Consequences of a Tax Deed on the Mortgage

If the property owner or the mortgage holder fails to redeem the tax lien within the statutory redemption period, the process can culminate in the issuance of a tax deed. A tax deed is a legal document that transfers ownership of the property to the tax lien buyer. This occurs after the redemption period expires and the tax lien buyer initiates legal action to obtain the deed.

Once a tax deed is issued, it extinguishes all prior liens on the property, including existing mortgages. This means the new owner, who acquired the property through the tax deed sale, takes possession of the property free and clear of the previous mortgage. The mortgage holder’s claim on the property is effectively wiped out, leaving them with an unsecured debt against the former property owner. While certain governmental liens or easements might survive, private liens such as mortgages are eliminated, highlighting the risk for lenders.