How the Proceeds of a Foreclosure Sale are Distributed
In a foreclosure sale, the mortgaged property is sold to the high bidder in a public auction. If the property is foreclosed in a judicial action, a sheriff or other public official may conduct the sale; if it’s foreclosed in a nonjudicial action, the trustee conducts the sale. State statutes specify when and where such sales may be held, but the location is often the courthouse.
The money paid by the highest bidder is distributed as follows:
The costs of the sale and the debt owed to the foreclosing mortgagee are paid first.
The mortgagee’s only interest in the property is to be fully repaid, however, so if any money is left over, the mortgagee doesn’t get to keep it.
The surplus is distributed to owners of junior interests in order of priority (which is generally the order in which the interests were created).
The sale extinguishes junior interests in the property, so these parties have a claim against the proceeds to compensate them for their loss.
The mortgagor gets to keep any money that’s left after paying the junior interests.
Imagine that after mortgaging her property, the mortgagor sold an easement to a neighbor and then gave a second mortgage to secure a home equity loan. If the first mortgagee forecloses, the proceeds of the foreclosure sale are first used to pay the costs of sale and to pay off the outstanding debt on the foreclosed mortgage.
If any money remains, the easement holder receives the market value of her lost easement. Any remaining surplus is applied to the home equity loan. And if that loan is fully paid and money still remains from the foreclosure sale, the mortgagor keeps the rest.
The mortgagor may complain that the high bidder at the foreclosure sale bid an unfairly low amount. In general, however, a low winning bid invalidates a sale only if it’s grossly inadequate, something like 20 percent of the property’s market value or less.
But if the foreclosure proceedings were irregular in some way that caused a low bid, a court may invalidate the sale even though the bid was a higher percentage of the property’s market value. Courts have invalidated sales for reasons such as the following:
The foreclosing mortgagee didn’t provide correct notices as required by statute.
The high bidder colluded with other prospective bidders to reduce the amount bid, such as by agreeing to share profits or paying them money not to bid.
The foreclosing mortgagee misrepresented the property’s condition or title or otherwise suppressed bidding by others.
The foreclosing mortgagee sold multiple mortgaged parcels in combinations or in an order that wasn’t the most beneficial to the mortgagor.
The party conducting the sale was the high bidder.
Any interests that are senior to the foreclosed mortgage — interests that were created earlier in time — are not affected by the foreclosure sale. Those interests simply remain attached to the property now owned by the high bidder at the foreclosure sale. Because the owners of the senior interests aren’t affected by the foreclosure sale, they have no claim to the proceeds of the sale.
The foreclosing mortgagee can and usually does bid at the foreclosure sale. If the foreclosing mortgagee is the high bidder, it essentially pays itself up to the amount of its debt by canceling the debt to the extent of its bid. The foreclosing mortgagee only has to come up with cash if it bids more than the amount of its debt.