Lien: Definition & Overview
Taking out a loan can provide you with more financial freedom to be able to do what you want. It could be to renovate your home, finance a future trip, or fund future business endeavors. Regardless of the reason, you’ll still need to pay the loan back at a future point in time.
However, there can be times when debts aren’t paid, and creditors need to be able to take action. So, how do they do this? Well, one way is by placing a lien against your property, but there can also be other factors to consider. Continue reading to learn how a lien works, the different types, an example, and more!
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KEY TAKEAWAYS
- Liens allow banks, mortgage companies, and financial institutions to lower their risk by collateralizing the property that customers purchase with a secured loan.
- Non-payment of a tax obligation, mortgage, or other secured loans could result in using a lien to seize assets and sell them to cover the cost of the loan or taxes.
- There are several types of liens including a bank lien, property tax lien, mechanic’s lien, and more.
What Is a Lien?
A lien is a voluntary or statutory claim against property that was used as collateral to secure a debt. It can also be used as a legal right to claim assets to satisfy a payment obligation. Liens essentially protect the interests of creditors against owners of the property or other assets who are unable to pay debts according to their agreed contract.
In simple terms, a lien entitles a creditor to your property if you’re unable to meet the payment obligations you have with them. It guarantees that the creditor will receive payment through the collateral even if you’re unable to pay.
How Liens Work
A lien grants a claim to the property by the owner to a mortgage company, bank, court, or local government when a property owner fails to pay their property taxes, income taxes, mortgage, or other type of judgment against their assets. When a borrower doesn’t pay their debt according to the contract, a lien is used to legally seize the collateral named within the loan and resell it to recover the funds from the loan. For mortgages, this results in foreclosure, and for a car loan this results in a repossession of the vehicle.
For banks, mortgage companies, and financial institutions, liens are a good thing. Liens lower the risk of lending large amounts to borrowers by collateralizing their property purchase with a secured loan. Many times this results in a lower interest rate for the borrower and secure investment for the bank. Many times, a property lien may prevent the sale or refinancing of a property unless it’s paid off and a lien release is issued. Liens can even impact your ability to qualify for credit.
Types of Liens
There are several types of liens that exist. Oddly enough, if all goes well and payments are made on time, then the lien won’t negatively impact you. It’s only when payment obligations aren’t met that the lien becomes an issue. Keep in mind, that as the borrower, you should follow-up with the lender to ensure that they discharged the lien as part of the due diligence process.
- Bank Lien: A bank lien is when a loan is issued from a financial institution to purchase an asset. The asset is then used as collateral for the loan. A car loan is a good example of this. If several payments are missed on the car loan, a lien is used to repossess the car and sell it.
- Mortgage Liens: All mortgages automatically include a lien on the property until the mortgage is paid off. This is a voluntary lien that uses the house as collateral for the loan in exchange for the monthly payments.
- Property Tax Liens: In some cases, property taxes are escrowed in with the mortgage so they’re paid automatically. If there’s no mortgage or the property taxes aren’t escrowed, then a delinquent property tax bill may result in a lien.
- Judgment Lien: If someone sues you and the court finds you responsible for paying them then a judgment lien might be issued liquidating your assets to grant payment to the defendant.
- Mechanic’s Lien: This takes place when a contractor renders services but isn’t paid for their work. The contractor would take the non-payment case to court. If the court places a judgment lien then assets can be auctioned off to pay the lien holder. This is common with construction, dry cleaners, or contractors.
- Real Estate Lien: This grants the lienholder the right to seize property if a contract is not fulfilled. Sometimes this might be a mortgage lien. Other times, it could be because of unpaid obligations with a creditor.
- Tax Liens: These statutory liens are used for delinquent taxpayers where local, state, or federal governments can place liens on bank accounts and assets to collect back taxes. Often the only way to resolve these liens is to reach a settlement with the IRS or make a full payment to satisfy the lien.
What Is an Example of a Lien?
There are two different examples of a lien: voluntary lien and statutory lien. When getting a mortgage to buy a property, a lien against the property you’re buying is included in the paperwork you sign. As long as you continue making payments as scheduled by your mortgage loan agreement, you won’t even notice that a lien is present.
The lien is used to secure your home as collateral for the loan. Since you agreed to have the lien placed as part of your mortgage, it’s considered a voluntary lien. If you stop making payments this lien enables the mortgage company to foreclose on the house to recuperate their loss from the missed payments.
The second type of lien is a statutory lien, which is when legal action is taken against you for non-payment of a debt. It could be in the form of a judgment, tax lien, or mechanic’s lien.
For example, If you hired a construction company to build a house, but didn’t pay them for their work, they could pursue a judgment against you through the court system for non-payment. This would allow property or assets to be auctioned off to satisfy payment.
Summary
Overall, a lien is used to help creditors secure the repayment of a loan or obligation based on a contract. If a debtor falls behind on their payments, then a lien is used to seize the collateral securing the loan. Liens are also used to enforce the payment of back taxes and court judgments. For people who are up to date on their payment obligations, liens help you get the home or car that you want without paying the full amount at once.
Frequently Asked Questions About Liens
Another word for lien is a claim.
A lien is not the same as a loan; however, a lien might be a requirement to secure a loan.
If a lien expires, the lienholder becomes a general creditor. This minimizes the return they’ll have on their lien. So, if the debtor defaults on their payments, the expired lien holder can sue, but will get access to any funds in the order that they placed the lien. The first lienholder has primary access to any liquidated funds. The secondary lienholder gets what’s left after that and so on.
A mortgage is a contract between a buyer and a mortgage company to meet payment obligations. Getting a mortgage requires a voluntary lien to be placed on the property to secure the loan. A lien is what secures the mortgage, and the mortgage secures the payments.
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