What is a Lien? Types of Liens and How They Work

A lien typically stays in place until a loan or debt is paid off

Liens
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A lien (pronounced like "lean") is a claim that someone or something has on a property that you possess or use. The individual or entity that has the claim—such as a lender – is called a lienholder.

An example of a lien is a payment agreement for a car loan. The loan document includes provisions that allow the lender to keep you from selling the car until you pay what you owe.

The word "lien" comes from the Latin for "to bind" (like ligaments, for example). Liens bind a debtor to the lender for a property until the debt is paid off.

When the property is sold, the lien must be discharged (paid), so the sale can be completed.

Property in these cases can be both real property (land and buildings) or personal property, like a car or business equipment.

What's the Difference Between a Lien, a Loan, and a Mortgage?

A loan is money given to you by a lender. A mortgage is just a type of loan, for real property (land and building).

A lien is a record put on the property you are buying, to allow the lender to hold the ownership of the property in case you don't pay.

How a Lien Works

Let's take the case of a lien on a car you buy for your business. You would usually buy the car from a dealer, secured by a loan from a bank, and the bank then puts a lien on it and holds the title.

The lender has what's called a security interest in the property, meaning that the ownership of the car stays with the lender, so if the borrower defaults (fails to pay), the lender can sell the car to recover the amount of the loan . A UCC-1 form is filed to record the lien. 

There are three possible outcomes to a loan that includes a lien:

  • You might make all the payments and pay off the loan on the car. The bank will release the title when that happens and the lien is removed.
  • Or you might stop making payments. The bank would continue to hold the title until the vehicle is subsequently sold to and paid for by someone else. This releases the lien, and the original lien would no longer exist at that point.
  • Or, you might try to sell the car while you still owe money to the bank. The bank still holds the title, so you must pay off the bank to release the lien and get the title to the car to sell it.

Contract terms and state laws govern what a lienholder or lender can and cannot do if they want to repossess or foreclose on a property. Repossessions and foreclosures also affect the borrower's credit rating.

Types of Liens

Consensual liens are those you agree or consent to when you purchase something through financing. You want the loan and it comes hand-in-hand with a consensual lien until you pay it off. A lien on a car loan, with the car as collateral, is an example of this type.

Statutory or non-consensual liens are obtained through a court order to put a claim on an asset for unpaid bills. Some types of statutory liens are:

Tax lien. A lien is placed against the property of someone by a federal, state, or local government for non-payment of taxes. The lien essentially gives the government a security interest in the property, and the tax lien must be paid before the mortgage.

In the case of an IRS tax lien, for example, the IRS must first send a notice of the tax due and a demand for payment. The lien attaches to all of the debtor's assets [such as property, securities, vehicles, including the right to accounts receivable (payments from customers). It also attaches to future assets you acquired during the duration of the lien. 

A tax lien may limit your ability to get credit and it may continue after a bankruptcy (in other words, you may still owe the taxes).

Mechanic's lien. A mechanic's lien is most often brought by a contractor or subcontractor. A contractor might do work for a homeowner but the homeowner doesn't pay. The contractor must go to court to get a judgment against the homeowner for the money. The judgment can be used to place a lien on the home.

Attorney's lien. An attorney can get a lien to hold a client's property until the client pays for legal services. This type of lien is common in personal injury cases, to make sure the attorney is taken out of the client's award. 

Judgment lien. This type of lien is awarded by a court as a result of a lawsuit. If you "win" the lawsuit, a judgment may be the only way to get your money. This type of lien is common in small claims court cases.

When Property Is Sold

Liens against assets must be paid off when the individual using the asset sells it. They can't receive payment for the sale until this happens.

In the example of the traded-in vehicle, the lender won't release the title until the lien is paid off in full. You have the use of the property while it's being paid off in most cases but the creditor/lender sometimes actually holds the property.

Liens in Bankruptcy

Liens also figure in bankruptcy proceedings because they involve secured loans and repayment of debt. Some liens can be discharged in bankruptcy, releasing the debtor from liability for the debt. Some liens may remain after the bankruptcy (as is the case with tax liens, mentioned above). The timing of the discharge depends on the type of bankruptcy. 

How to Get Rid of a Lien

Paying the amount you owe - in full - is the best way to get rid of a lien. A "release of lien" is a written statement that removes the property from the threat of the lien, usually in the case of a mechanic's lien or a tax lien.  It should be signed at payment as proof of payment and as an assurance that the property will not have a judgment placed against it. 

Article Sources

  1. Legal Information Institute. "Secured transactions." Accessed Feb. 3, 2020.

  2. SCORE."25 Small business Loan Terms You Need to Know." Accessed Feb. 3, 2020.

  3. Legal Information Institute. "Tax lien." Accessed Feb. 3, 2020.

  4. IRS. "Understanding a Federal Tax Lien." Accessed Feb. 3, 2020.

  5. Legal Information Institute. "Mechanic's Lien." Accessed Feb. 3, 2020.

  6. Legal Information Institute. "Attorney's Lien." Accessed Feb. 3, 2020.

  7. United States Courts. "Discharge in Bankruptcy - Bankruptcy Basics." Accessed Feb. 3, 2020.

  8. Legal Information Institute. "Release of lien or discharge of property." Accessed Feb. 3, 2020.