[onewhippedpuppy]

Jeff, I became better acquainted with this issue recently, when we found that a house we had planned to buy had an IRS lien on it. We didn't buy, but I did some research and asked a lot of questions.

In a forclosure, the bank assumes not only the deed to the property, but all claims against it. Therefore, in order for the bank to own the property free and clear they have to pay all liens first. This is of course necessary for the bank to sell the property.

If you are talking sale instead of forclosure, the lienholder is the last to be paid, because the liens must be taken care of in order for the property to close. When there is not enough equity in the property to pay off the loan, there will still be a balance that has to be paid by the borrower.

Another case is a property facing forclosure, with an intersted buyer. In this case, sometimes the bank will do a short sale, where they actually write off a portion of the principal. This allows the liens to be paid out of equity, and the bank still gets SOMETHING. Also, they aren't left trying to collect money from a borrower who obviously was not paying anyway. Often times the bank still makes out OK, because of the large amount of interest that has been paid in the first few years of the loan. They really only lose money on paper.

Forclosures are a tricky deal, and vary from state to state. Around here, most are auction format, with the bank placing the first bid for the amount of principal owed. In cases where this is not realistic, the bank may bid less and take a loss. Buyers have to be careful though, because the original borrower has up to one year to essentially take back the property by paying their loan up to current. If this happens, you are screwed. Many guys that flip houses buy the homeowner's rights from them, so they immediately own it with no worries. Talk to someone that does this often, or a RE lawyer, they can give you the particulars for CA.