What is a Lien – and What Does It do to Your Credit Report?
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Creditors will often slide in a provision that protects their interests if you fail to make payments on a loan for a long time. Liens are a common way to ensure owners pay valid debts because they give lienholders a legal claim over the said asset.
This article will walk you through the ins and outs of a lien if it affects your credit score, and what you can do to remove a lien. (Spoiler alert: don't get your hopes up).
In this article
What is a lien?
A lien is a legal claim against an asset used as collateral to satisfy debt repayments. Put another way, a lien serves as a guarantee of the repayment of a loan. Liens are a standard method used by creditors to collect their money because when a creditor puts a lien on your asset, that asset serves as a collateral for the debt. If the borrower cannot fulfill the debt obligation, their asset can be seized by the creditor. For example, if a lender places a lien on your home, car, or another asset, you could lose it and are more likely going to find a way to pay the money back. Liens are usually public records, which means if you have lien on an asset, anybody can find out about it provided they know where to look.
And liens are bad news if you're looking to sell a real estate or a vehicle subject to a lien without clearing the debt because both require a clear title, meaning you must repay the loan before you offload the asset. Like I said, creditors know liens are a nearly guaranteed way of getting the money they're owed.
Bank lien, judgment lien, real estate lien and tax lien are some of the most common types of liens. Mechanic's lien (also known as a construction lien) is another type of lien. Regardless, all liens work in the same manner. If your property faces foreclosure, certain types of liens determine which creditor will get paid first. A legal doctrine known as "first in time, first in right" means the first of the two liens to attach and become enforceable has priority over other liens on the same asset.
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How does a lien work?
A lien gives creditors the right to sell your asset, provided you have been unable to make payments on a loan. Liens can be consensual. For example, you go to a lender to get a loan, and you consent that a lien be put on an asset. However, not all liens are voluntary. If you take out a loan and fail to make payments for a long time, the creditor may pursue legal action against you for nonpayment. If the court allows, a lien may be placed on an asset such as property or a bank account.
As noted, liens are made a part of the public records. This prevents anyone from selling the asset because when a potential buyer conducts a title search at the county or the state level, they'll know a lien has been placed against your property that hasn't been cleared yet.
In addition to creditors, local governments can file liens if you have unpaid taxes such as income tax. The IRS, for example, can seize properties if you don't pay a tax debt. But if you make the payment to Uncle Sam, you qualify for a lien release, which the IRS does within 30 days.
Major types of liens
Bank lien
As the same suggests, bank liens are placed by banks or other financial institutions on a loan taken to purchase an asset. For example, if you take out a loan from a bank to buy a car, the bank may place a lien on the vehicle to ensure you continue making monthly payments. This is the most common type of lien and voluntary, and it's documents are included among the many papers you sign when closing on a purchase.
If the borrower fails to satisfy their financial obligations to the bank, the financial institution may exercise its right and seize the vehicle with the intention of selling it in a bid to recoup its costs.
Judgment lien
These liens are involuntary from the borrowers' perspective, and they are placed on an asset after a creditor seeks legal recourse if you haven't made payments on a loan for a specific period. Judgment liens are also applicable in a criminal lawsuit. The court can pass a judgment to liquidate or sell the convicted individual's property and pay the money to their victims.
If a judgment lien has been made on property of yours, not only can the asset not be sold, but you also can't borrow against the asset in question. The lienholder (i.e., whoever files for the lien and takes you to court) can choose to foreclose on your property if you fail to satisfy the terms of the lien.
Real estate lien
Liens can be placed on any asset like a car or bank account. But a real estate lien can only be put on a property. As with other liens, a mortgage lien gives the lienholder the legal right to seize and sell the property if you've failed to remain current on your payments for a certain period of time. Real estate lien can be both voluntary and non-consensual. If you agree beforehand that a lien is placed on a property while you seek a loan from a bank, that makes it consensual. But if you take out a loan, fail to make payments, and the creditor takes you to court, then a real estate lien becomes involuntary.
Related: | How to Make Money Investing in Real Estate
Tax lien
Tax liens are statutory, meaning they are enforced not as a result of a contract violation and don't need your consent either. The law permits tax authorities, such as your local government, to take control of your property if you haven't paid taxes. On the federal level, the Internal Revenue Service (IRS) is authorized to place a lien against the culprit's assets, including their property, bank accounts, or an automobile, if they've neglected to pay their dues despite constant reminders.
This IRS uses this as an option of last resort after exhausting other methods, like settlements or customized repayment plans. The procedure works by first serving a federal tax lien notice, notifying the individual of the lien and the occurrence of a sheriff's sale. It is a public auction organized by the county sheriff's department to sell the property, satisfying the bank, government, or lender's debts.
A tax lien can be released by paying the tax owed or negotiating with the IRS.
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Does a lien affect credit scores?
Yes and no. Some liens aren't included in your Instead, they are reflected through a borrower's inability to pay debt, affecting your credit score. I know it is complicated, but maybe this example will help clear it up for you: You take out a mortgage loan and agree that a lien be placed on your newly bought property. But you hit financial hardship and fail to make payments, leading the bank to sell your property. This noncompliance to pay the debt will show up on your payment history and be reflected on your report, but a lien itself will not. As noted, a lien is reported to local and state governments, depending on the type of lien. When you clear your debt obligation and repay the money you owe, your credit report will reflect the updated information.
However, a judgment lien — when a creditor sues you, and a court grants them a lien on your assets — does affect your ability to obtain financing in the future. A statutory lien, where a law enforcement agency takes control of your assets, also impacts your credit score.
How to get rid of a lien
In most cases, a lien can only be removed once you've fully paid the money you owe. Remember: you can't sell an asset subject to a lien.
But, there are a few methods you can try to have a lien removed, though your chances of success wouldn't be high:
- Settlement: If you're under financial stress, you can try to make your situation clear to the creditor. Chances are slim, but a creditor may be willing to accept an amount lower than what you owe, and they may see it as a way to recoup some of the costs instead of losing everything.
- Legal action: Another method, albeit expensive, is to dispute the legitimacy of a lien in a court. It's also worth looking into your state's statute of limitations to see if any claims are still valid or not.
- Corrections: Removed liens have a way of getting lost or forgotten. If you bought an asset that had a lien that has now been paid, the lien might have fallen through the cracks. In this case, you don't have to pay anything; you only have to contact the right person.
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The bottom line
A lien is a legal right that allows a creditor to seize an asset and sell it to recoup its losses. Lien placed on an asset can either be voluntary or non-consensual. Different liens are placed on fixed assets like houses and unfixed assets like a bank account. A creditor or the government may enforce liens.
Banks execute bank liens, judgment liens by courts, and local or federal governments may enforce tax liens. Voluntary liens do not affect your credit score, while liens ordered by a court impact your ability to secure financing in the future. An asset subject to a lien cannot be sold, and the only way (in most cases) to remove a lien is to pay the money you owe to the creditor.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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