In a typical mortgage foreclosure, the foreclosing lender has a first-priority lien on the property, which means that the foreclosure extinguishes (or wipes out) any junior liens on the property. Junior liens are any liens that are put on the public record after the recording of the first mortgage. Examples include second mortgages or home-equity lines of credit, federal and state tax liens, judgments obtained by other creditors, and yes, HOA liens. The homeowner’s actual debts to those creditors are NOT erased by the mortgage foreclosure, but as junior-lien holders, they have lost the ability to collect their debts by enforcing their liens against the property.
If you are the holder of a junior lien when a foreclosure occurs, you generally have two options to recover the balance owed to you by the previous homeowner: You can file a lawsuit against the homeowner, or you can turn the account over to a collection agency.
Filing a lawsuit to collect a debt is fraught with uncertainty. You have to locate the homeowner at his new address, pay an attorney to file the lawsuit, go to court and obtain a judgment, and then try to collect on the judgment. Moreover, just because you are awarded a judgment against the debtor does not mean you get paid. It just means you can try to collect the debt by having the sheriff seize the debtor’s property, if any, and sell it at a public auction. The process of enforcing a judgment can be difficult. Besides, most people who just lost their home in a mortgage foreclosure are not likely to have significant assets at their disposal.
As for collection agencies, some of my HOA clients have used them in the past with mixed results. Using a collection agency usually doesn’t cost the HOA anything, since most of the agencies work on a contingent-fee basis, such that the collection agency’s fee is a percentage of whatever it collects. However, most HOAs just write off the bad debt following a mortgage foreclosure because the cost and hassle of pursuing the debt are usually not worth the effort.
It is nevertheless important for an HOA to have its lien in place when a property goes into a mortgage foreclosure (assuming, of course, that there are past-due HOA assessments). During and in the years following the Great Recession, there weren’t many investors bidding at foreclosure sales. As a result, mortgage lenders would “bid in” the amount that was owed on the mortgage (sometimes less) and take title to the property. These days, real-estate prices have rebounded, demand is up, and supply is low, and we see a lot more homes sold at foreclosure for more than what is owed on the mortgage. When this happens, there are “surplus proceeds” available. This is the amount of money left over after the mortgage and foreclosure expenses have been paid. The lender typically pays these surplus funds into the Clerk of Court. Thereafter, the former owner and other creditors whose liens were extinguished can petition the court to have those funds paid over to them. The court must pay the liens in the order of their priority, to the extent funds are available, with any remaining funds paid to the former owner. With an improved economy and real-estate market, the odds for getting paid through surplus proceeds remaining after a mortgage foreclosure are better than they were a few years ago.