A lien is a financial claim that a person or company has on a property. Liens are generally placed on real property, such as homes and commercial buildings, but they can also be placed on other forms of property, such as cars, investments, and business equipment.
How Do Liens Work?
The word “lien” comes from the Latin word ligare, which means “to bind”—so a lien binds a debtor to the property.
Like a boat anchor, liens are financial anchors that hold a property back until released. They limit what can be done with a property, including selling it.
In fact, liens give the creditors legal rights, which can include foreclosing on the property and selling it to satisfy the lien.
Getting a lien requires making a court filing in the county where the property is located. Different localities and states have different laws and procedures around filing liens.
Different Types of Liens
Liens can either be consensual or nonconsensual (also known as statutory).
Consensual liens (also known as a voluntary lien) are ones you agree to—like when your home or car serves as collateral for a mortgage or auto loan. For example, a mortgage lien remains on your home until the debt is paid.
Nonconsensual or involuntary liens, meanwhile, are put on a property because of outstanding debt. There are several common types of nonconsensual liens:
A mechanic’s lien is generally levied by a contractor or subcontractor for unpaid work on a home or property. In order to put a mechanic’s lien on the property, the contractor or subcontractor needs to go to court to get a judgment.
Tax liens are statutory liens for unpaid taxes placed by the taxing authority: either a federal, state, or local government. One common example is property tax liens. These liens must be paid before mortgages.
An Internal Revenue Service (IRS) tax lien attaches to all current and future assets, including personal property, motor vehicles, and investments. A federal tax lien in the United States will rarely be a surprise: The IRS will send a notice of tax due and demand payment before placing a lien.
A judgment lien can be awarded by judges if someone files a lawsuit for money owed and wins. Filing a judgment lien on the property as part of the judgment might be the only way to collect the money due.
A judgment lien is commonly awarded in small claims court cases.
Attorney’s liens ensure payment for legal bills. This type of lien, often used in personal injury cases, ensures the attorney is paid necessary legal fees out of the client’s award.
While these types of liens are most common, there are others that could impact you.
Lien vs. Encumbrance
An encumbrance is, broadly, a third-party claim against your property.
A property lien is an encumbrance, but not all encumbrances are liens—liens are the only financial-related encumbrance. They’re also the most common encumbrance.
Other encumbrances include deed restrictions, easements, and encroachments, which can place restrictions on how an asset can be used or limit the transfer of the property:
- Deed restrictions limit the use of a property, such as limiting changes to historical elements of a home.
- Easements give a third party a legal right to use the land—utility companies, for example, generally have easements to assess equipment and construct power lines.
- Encroachments are when another property owner’s structure intrudes on your land.
Removing Liens From a Property
The easiest way to get a lien lifted is by payment of a debt. Alternatively, the lien holder and property owner can agree to a repayment plan on the condition that the lien holder remove the lien.
Although liens are secured loans, some can be discharged in bankruptcy.
Selling or foreclosing on the property can also satisfy a lien—the sale proceeds will be used to pay the debt holder. However, this can hurt the property owner’s credit rating if the lean was nonconsensual.
If the owner sells the property, they must pay off the liens. For example, a financed car will have a lien attached to the title. In order for the individual to sell or trade in the car, the remaining debt must first be paid to the lender.
Tax Lien Investing as a Real Estate Strategy
Investing in tax liens is an alternative real estate strategy that can offer high returns. However, it’s a sector that requires specialized knowledge and a proactive approach to minimize risk.
Here are the steps for getting started:
1. Understand what a tax lien is
Before diving in, it’s crucial to understand what is a lien. A tax lien is a legal claim by a government authority against a property when the property owner fails to pay taxes on it. The lien secures the government’s claim on all proceeds from the sale of the property, and in some cases, an investor can acquire the property itself.
2. Research the rules and regulations
Tax lien laws vary by state, so familiarize yourself with the rules, interest rates, and redemption periods that apply in your area of interest. Some jurisdictions have online resources, or you can consult with legal professionals experienced in tax lien investments.
3. Assess the risk and return
The returns on tax liens can be enticing, but they are not without risk. Assess the property condition, neighborhood, and market trends. A detailed due diligence process can help you gauge the potential returns against the risks involved.
4. Attend tax lien auctions
Tax liens are often sold through public auctions. You can attend these either in person or online. Be sure you set a budget beforehand and stick to it to avoid overbidding.
5. Monitor your investment
Once you own a tax lien certificate, it’s critical to monitor your investment. Keep track of the redemption period, during which the homeowner can repay the back taxes, with interest, to reclaim their property. If the period expires without payment, you may have the option to foreclose on the property.
6. Exit strategy
Have a clear exit strategy in place. Whether it’s collecting on the lien plus interest, obtaining the property through foreclosure, or selling your lien to another investor, knowing your end game will help you manage your investment effectively.
7. Rinse and repeat
After you’ve completed one successful tax lien investment, assess what you’ve learned and apply it to future investments. This is a sector where experience and specialized knowledge can significantly boost your returns.
In general terms, a lien is a way of saying that someone owes money. Liens can be attached to things like houses, cars, or other valuable items. Knowing how liens work can help you in two ways.
First, it can protect you from getting into trouble with your own property. And second, you can make money by investing in certain kinds of liens.
Now that we’ve answered the question “what is a lien,” you’re in a better position to make informed decisions regarding your own property or when investing.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.