A lien represents a legal claim a creditor or lender holds against your property or assets if you fail to fulfill your debt repayment obligations. Homeowners with mortgages are typically familiar with liens, as their property is subject to one until the mortgage is fully paid. Liens serve as a protective measure for lenders, securing their investments, but they also function as a mechanism for creditors to recover unpaid debts.
Let’s delve into the mechanics of liens and explore the various types that exist.
How Does a Lien Work?
When you provide collateral for a loan, the lender needs assurance that they can seize the property to recover their losses if you default. A lien provides this legal recourse.
Alt: Car serving as collateral for a loan, illustrating how lenders secure their investment through lien rights.
There are two primary categories of liens: voluntary and involuntary.
While both types accomplish the same goal, involuntary liens are generally viewed negatively because they arise from non-payment. Voluntary liens, such as mortgages or auto loans, are a standard aspect of borrowing, providing a way for debt recovery in case of default.
What Are the Different Types of Liens?
Various types of liens can be filed against you. As mentioned, some are voluntary, while others are imposed by creditors due to non-payment, without your explicit consent.
Here’s a breakdown of different lien types and the circumstances surrounding their establishment:
Real Estate Lien
A real estate lien grants the creditor the right to seize and sell real estate if the borrower defaults on their agreement. Mortgages are the most common example of real estate liens, and a voluntary lien agreed upon when borrowing money to purchase a home.
Additional liens, both voluntary and involuntary, can be placed against your real property. For instance, taking out a second mortgage or using your home equity as collateral results in a second (or third) lien being recorded against the property. In such cases, the lienholders’ priority is determined by the filing date. Lien priority dictates who gets paid first when selling the home or if the property is liquidated or foreclosed.
Bank Lien
A bank lien gives the bank the legal right to assets pledged as collateral for a debt or loan, such as a home, car, or personal loan. This allows the bank to seize and sell the collateral to recover losses if the borrower defaults on the debt.
Tax Lien
A tax lien is an involuntary lien placed on your property for failing to pay state or federal taxes. These liens have priority over all other liens and must be paid first. Federal and state tax liens can be placed on various assets, including personal property. Prolonged non-payment of tax liens could lead to the forced sale of your property, with proceeds used to pay lienholders.
Alt: Example of a 1040EZ tax form, demonstrating the importance of tax compliance to avoid tax liens.
Judgment Lien
A judgment lien is placed on your property or assets by a court, establishing that you have outstanding debt. Creditors who can prove you defaulted on an agreement and owe them money can file judgment liens in local courts. Similar to other liens, lienholders will be paid from the proceeds of any sale of your property.
Mechanic’s or Construction Lien
These liens are filed through the court and placed against real property when a contractor or subcontractor performed work and hasn’t been paid by the property owner. A construction or mechanic’s lien can only be placed on the property where the work was performed.
Child Support Lien
Most states allow liens to be placed on a parent’s property when they fail to pay court-ordered child support. These liens can be attached to real estate, vehicles, bank accounts, and other valuable assets. The lien remains in place until all overdue support is paid, the child is no longer eligible for support, or the custodial parent agrees to cancel it.
Does a Lien Appear on Your Credit Report?
Liens themselves are not reported on credit reports since 2018. However, for real estate and bank liens, the loans associated with the lien are still listed on your credit reports.
The three major credit bureaus (Experian, TransUnion, and Equifax) stopped reporting civil judgments and tax liens on credit reports after a CFPB study highlighted inaccuracies in reporting such information.
Currently, bankruptcies are the only public records included on credit reports. Chapter 13 bankruptcies remain on reports for seven years from the filing date, while Chapter 7 bankruptcies stay on reports for ten years.
What Happens if I Don’t Pay a Lien?
Paying off a lien results in its removal from your property. However, if you fail to pay, the lender or creditor has the right to seize the property or asset to cover the debt. For example, failure to pay a mortgage lien could lead to foreclosure, where the lender sells the property to recover their losses. Sale proceeds are used to repay the lienholders, provided there are sufficient funds.
While non-mortgage lien foreclosures are less common, they are still possible. Typically, the creditor who filed the lien must wait until you sell or refinance the home, at which point they are entitled to what they are owed.
If foreclosure proceeds are insufficient to repay all debts, creditors can pursue outstanding balances. Liens can also be transferred to other current or future properties owned by the debtor.
How an Unpaid Lien Can Negatively Impact Your Credit
Although unpaid liens themselves don’t appear on your credit report, they can still negatively impact your credit if the associated debt goes unpaid. Lenders report payment history to the credit bureaus, so a record of non-payment could appear on your credit report. Payment history is a critical factor in calculating your credit score, accounting for 35% of your FICO® Score.
Even though liens don’t appear on credit reports, they are public records. If a lender discovers an unpaid lien, it could impact your ability to qualify for new credit.
How to Remove a Lien
Here are the common options for removing a lien against your home, car, or other property:
- Pay it off: If the lien is valid, the most direct way to remove it is to pay it off. Contact the lienholder to determine the exact balance required to satisfy the lien. Your lender might be willing to set up a payment plan.
- Obtain a lien release: After repaying the debt, have your lender sign a lien release document relinquishing their claim on your property. File the signed release form at your local county recorder’s office to officially remove the lien.
- Negotiate a settlement: If you’re unable to repay the debt in full, negotiate with your creditor for a reduced settlement amount, often in exchange for a lump-sum payment.
- Dispute the lien’s validity: If you believe the lien is invalid, challenge it in court. A judge may dismiss it if the lienholder can’t prove its validity.
Pay Attention to Your Credit
While liens themselves may not be on your credit report, missed payments related to the debt that created the lien will be. Consistent on-time debt payments are crucial to maintaining a healthy credit score. Keeping credit card balances low is also important, as your credit utilization ratio accounts for 30% of your credit score.
Regularly monitor your credit report and credit score to stay informed about your credit standing and identify any factors impacting your scores. Understanding what a lien is and how it impacts your assets is essential for sound financial management.
