Real Estate Liens: Overview & Characteristics

Instructor: Shawn Grimsley
Liens are one of the most common encumbrances on real estate. In this lesson, you'll learn what a lien is, ways they can be created, lien priority and termination, among other related concepts. A short quiz follows.

Understanding Liens

For purposes of real estate, a lien is a type of interest or claim on a parcel of real estate held by a creditor that secures payment of a loan or other debt owed to the creditor. A home mortgage is a common example. If the debtor defaults on the underlying debt, the creditor has a right to pursue payment of the debt through the sale of the property subject to the lien.

If payment of a loan is secured by collateral (i.e., the property encumbered by the lien), it's called a secured loan. If a loan isn't secured by collateral, it's an unsecured loan. A person who holds the lien is sometimes referred to as the lienholder.

Most first-time homeowners can't afford to pay for their new home with 100% cash, so they go to a bank to take out a loan. The bank wants more than your contractual promise (i.e., your promissory note) to cover the $200,000 it's forking over to let you buy your home; it wants you to put up the property you are buying as collateral to secure the payment of the loan in case you default. Consequently, you'll not only give the bank a promissory note promising payment but also a mortgage against the home securing the payment. The mortgage is recorded at the county recorder's office and becomes a lien on your property. If you don't pay up, the lender may file an action in court for foreclosure, which may result in your house being sold to satisfy the debt.

You need to keep in mind that not all property liens actually involve debt that specifically relates to the real estate subject to the lien. For example, you may give a bank a lien on your home to secure a loan to start a new business. In this case, the underlying debt is not directly related to the property that is burdened by the lien.

Creation of Liens

Liens can be created by contract, operation of law (sometimes called a statutory lien) or through the principle of equity (equitable liens). A lien is created by contract when a debtor or borrower agrees to give a creditor a lien over a specific parcel of real estate and the other legal requirements for an enforceable contract are met. You should note that since a lien is an interest in real property, the legal instrument creating the lien must be in writing and signed by the borrower or debtor, or the lien will be unenforceable under the statute of frauds, which requires certain contracts to be in writing to be enforceable.

A lien created by operation of law, or statutory lien, is based upon a specific statute entitling the creditor to the lien if the requirements of the statute are met. Unlike a contractual lien, a statutory lien can be imposed involuntarily upon the property of the debtor. Examples include tax liens filed when a homeowner fails to pay her property taxes or mechanic's liens that secure payment for work and materials supplied during house construction or renovation.

An equitable lien is based on the judicial concept of equity, which is a sense of fundamental fairness seeking to avoid an injustice. An equitable lien may be imposed on property to avoid an unjust result. For example, let's say your trusted financial adviser decided to clean out your investment portfolio to buy a vacation property in Hawaii. A court may impose an equitable lien on the house (along with all the other property owned by the thief) that can then be liquidated to compensate you for the theft.

Lien Priority

What happens if there is more than one lien on the same piece of dirt? Which creditor gets paid first? You may think that the obvious answer is the lien that was created first. However, that's not always the case. Some statutory liens have favored priority as a matter of law, such as mechanic's liens in many states.

Additionally, if multiple liens are recorded but have the same statutory priority, the state's recording act will determine the seniority of the liens (senior is better). If the recording act has a race statute, the first person to file the lien wins priority regardless of whether the person had notice of a prior lien that has yet been filed. On the other hand, in a race-notice state, that same creditor has to have filed first and not have notice of any earlier lien that has not been recorded yet. Let's look at an example.

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