Considering foreclosure or bank-owned properties can be lucrative when investing in real estate. Often, foreclosure and bank-owned properties sell below market value, providing a great opportunity for return on investment potential. However, before bidding on a property, it’s important to understand that real estate laws vary from state to state. One regulation to keep in mind is whether the property is located in a lien theory state or a title theory state.
But what is a lien theory state and a title theory state? In this guide, we’ll break down the difference between lien theory state vs. title theory states so you can understand the laws that dictate the type of property that interests you.
Different Stages of Mortgage Default
Before diving into the differences between a lien theory state vs. a title theory state, it’s important to understand the different stages homeowners might end up in as a result of being unable to uphold their mortgage requirements. Some of the most common stages of default include real estate owned (REO), foreclosure, and claims without conveyance of title (CWCOT). Let’s take a look at each stage below:
Foreclosure: A foreclosure is a property in the midst of the foreclosure process, which is a legal process that the lender initiates to recover the unpaid mortgage balance. The foreclosure process can vary by state, with some states following a judicial or nonjudicial foreclosure process. During the foreclosure process, the home might be put up at auction.
Real estate owned: An REO property is a property that has already been foreclosed upon, and the lender has taken ownership of the property through the foreclosure process. This occurs when the owner defaults on their mortgage, and the lender gains ownership of the property and tries to sell it to recoup the outstanding mortgage debt.
Claims without conveyance of title: CWCOT refers to the process used by the Department of Housing and Urban Development (HUD) on properties where homeowners defaulted on their FHA-insured mortgage. The CWCOT program uses third-party services to manage the property and sell it. Unlike with an REO, where the lender takes ownership, the property title remains with HUD until it is sold, typically at auction.
It’s important to note that laws vary by state when it comes to foreclosure, REO, or CWCOT homes. Because each state operates differently, it’s crucial for buyers to conduct their due diligence on liens and state laws that regulate the various auction programs.
Lien Theory vs. Title Theory
As you search for properties to invest in or a home to buy, in many cases, you’ll need to take out a mortgage. However, mortgage laws vary from state to state. These laws are put in place to protect buyers and sellers and dictate how a property can be foreclosed upon or sold. Two common real estate laws are the lien theory and title theory. But what’s the difference between lien theory states vs. title theory states? Below, we’ll explain each type of law so you can determine which one applies to the state where you’re looking to buy property.
What Is a Lien Theory State?
So, what is a lien theory state? A lien theory state refers to a state that operates under the lien theory of mortgage law. If you’re looking to buy in a lien theory state, the mortgage is considered a lien on the real estate property that secures the loan. This gives the lender, such as a bank, a claim to the property if the mortgage borrower fails to repay the loan or abide by the terms outlined in the mortgage agreement. The lien will no longer remain once the mortgage is paid in full.
Additionally, the lien will appear on the title search if the homeowner decides to sell the home before the mortgage is paid off. This means the lender can claim income from the sale to put toward the remaining balance of the loan before clearing the title and releasing the lien, allowing the sale to proceed.
In a lien theory state, the lender can foreclose on the property should the borrower default on the loan. In order for a foreclosure to proceed, it will often go through the court, which will determine whether the lender has the right to foreclose on the property and use the proceeds to repay the outstanding loan balance.
While the laws in lien theory states are typically the same, the procedures can vary slightly. With that said, it’s important to work with a real estate attorney to help navigate investing, purchasing, or selling a property in a lien theory state.
What Is a Title Theory State?
Now that you know what a lien theory state is, what is a title theory state? A title theory state is a state that follows the title theory of mortgage law. In a title theory state, the lender, not the homebuyer, holds the title to the property until the borrower repays the loan in full. The title of a property in a title theory state is held in a deed of trust, which outlines the agreement that the lender retains the legal title of the property until the mortgage is paid in full.
Although the property title is under the lender’s name, the borrower has the legal right to use and occupy the property. However, the lender can foreclose on the property if the borrower fails to make payments on the loan. The proceeds can then be used to recoup the unpaid balance.
Similar to lien theory states, the procedures in a title theory state can vary on a state-by-state basis, which is why working with a real estate attorney can be helpful.
What Is an Intermediate Theory State?
Now that we’ve covered title theory vs. lien theory states, it’s important to note that some states follow a third type of mortgage law: the intermediary theory. An intermediate theory state is a hybrid between a lien theory and a title theory state. In an intermediate theory state, the borrower holds the title to the property, but the lender can reclaim the title if the borrower defaults on their loan.
A mortgage in an intermediate theory state can be considered a transfer of title and a lien on the property. The borrower can retain some rights, such as occupying the property, but the lender has the legal right to foreclose on the property should the borrower default. However, in an intermediate theory state, the foreclosure process can vary based on the state.
So, an intermediate theory state is similar to a lien theory state in that the borrower holds the title of the home. However, it’s also similar to a title theory state in that the lender can reclaim the property title if the borrower defaults on their loan.
What’s the Difference and Why Does it Matter?
So, what’s the main difference between a lien theory state vs. title theory state? The primary difference lies in how the mortgage is handled and the ownership of the property during the loan. In a lien theory state, the mortgage is considered a lien on the property used to secure the loan, with the borrower retaining ownership of the property and the lender having the right to claim the property if the borrower defaults.
In a title theory state, the mortgage is considered a transfer of title from the borrower to the lender. The borrower can retain an equitable interest in the property, but the lender holds the title to the property and can foreclose on the property should the borrower default.
The difference between a lien theory state vs. title theory state matters for several reasons, such as the foreclosure procedure, property ownership, and borrower rights. Additionally, these mortgage laws vary by state, so it’s important to understand the laws of the respective state where you want to invest.
Difference in Foreclosure Proceedings
One of the primary differences between a lien theory state vs. title theory state is in foreclosure proceedings. While the differences can vary by state, there are some general differences. For example, in a lien theory state, the foreclosure process is often quicker and less expensive for the lender, as the lender only forecloses on the lien to the property. However, in title theory states, the title to the property must be transferred before foreclosure, which can involve more legal procedures and be more expensive and time-consuming.
Mortgages in title theory states have to go through a judicial process with the lender filing a foreclosure lawsuit. In contrast, a trustee manages foreclosures in a lien theory state and doesn't require a judicial process and involvement with a court.
Conclusion
If you’re looking to invest in real estate, purchasing foreclosure or bank-owned properties can be lucrative and offer a great return on investment. However, when purchasing a foreclosure property, understanding the mortgage laws surrounding it is important. Living in a lien theory state or a title theory state can influence how the foreclosure process plays out. It’s important to conduct your due diligence and seek professional guidance or speak with a state agent to learn more about specific state laws regarding liens.
At ServiceLink Auction, you can browse our upcoming auctions to find foreclosure and bank-owned properties for sale.