You may have heard the term, but what exactly is an encumbrance in real estate and what role does it play in the buying and selling process for real estate?
In almost any type of real estate transaction, you will be dealing with one or more encumbrances. An encumbrance can be a legal, financial, or personal responsibility that inhibits the use or transfer of a property. It is important to understand the various types of encumbrances and how they can affect the sale or transfer of a home, land, or other type of property.
What follows is a list of the primary types of real estate encumbrances. You will also learn how to satisfy or work around these to streamline the sale or transfer of real estate.
The primary type of encumbrance for most properties is either a mortgage (less common) -- an agreement between a borrower and lender -- or a deed of trust (more common) -- an agreement between a borrower, lender, and a trustee. Regardless of which financial instrument is in play, satisfying this encumbrance is required to sell or transfer property from one owner to another.
In most cases, paying off the encumbering mortgage or deed of trust results in a reconveyance deed. This clears the encumbrance from title and acknowledges the satisfaction of the previous debt. However, in the case of a bankruptcy, for example, the loan may not be formally released from the property. This can result in a cloud on the title if the subsequent owners are unwilling to pay for a release of the encumbrance.
A voluntary lien is debt that is secured by the property and voluntarily agreed to by the property owner. For example, a home equity line of credit is a popular instrument providing emergency cash, funds for home repairs and improvements, or funds for debt consolidation. It is secured by the equity in the home. Even if the borrower does not use the line of credit or has already paid it off, this line of credit has to be closed with the lender and the voluntary lien must be recorded as satisfied to allow the property to change hands.
An involuntary lien is one that is placed on the property with or without the consent of the property owner. There are a variety of types of involuntary liens, including:
1. Tax Lien: A tax lien is placed on a property to satisfy a governmental debt, including property tax or income tax owed. A federal tax lien overrides all other types of financial encumbrance and asset claims.
2. Mechanic’s Lien: A mechanic’s lien is placed on a property to satisfy a debt owed to a contractor or sub-contractor for work performed or materials provided in order to repair or upgrade the property.
3. Lis Pendens: This term means “pending legal action,” and is used when the property is involved in a legal question of ownership or contractual dispute. There are a variety of circumstances in which a lis pendens might be filed to prevent the sale or transfer of a property.
4. If a seller improperly ignores an existing sales contract to sell to someone else, the first buyer could file a lis pendens in order to prevent the sale until a court has determined which buyer is entitled to the purchase.
5. If an heir attempts to sell real estate gained through an inheritance, another heir can file a lis pendens to prevent the property sale until a judge has determined their eligibility to share in the inheritance.
6. A notice of lis pendens can be filed in the event of a divorce to prevent a spouse from arbitrarily selling a property prior to the agreement of the other spouse and the settlement of the division of marital assets.
Is an easement an encumbrance? Yes. Easements allow people or entities other than the property owner to use a portion of a privately held property. For example, an easement allows a utility company access to their lines or allows a neighbor access to the street from a landlocked property. This type of easement restricts certain uses and effects property rights for the owner.
Occasionally, a fence may stray onto a neighboring property, or a well-worn pathway may cut across a portion of privately held land. These types of encroachments are considered encumbrances. It is important that such encroachments are noted during surveys and inspections and, if necessary, that easements or abatements are put in place to ensure that the encroachments do not affect the ownership, marketability, or insurability of the property in question.
In some cases, private owners restrict the use of land for particular purposes or against specific use. These types of restrictions continue even after the land has passed on to heirs or into new ownership. It is important to understand what restrictions, if any, have been placed on the property in question. This is especially important in the case of large plots of land that have been divided and sold off as separate parcels.
Restrictive covenants come into play in areas of particular historical or architectural importance or in communities with strict rules regarding home styles and property appearance. In many cases, review boards, homeowners’ associations, and other entities may determine whether or not a homeowner is in compliance with the specific requirements of a restrictive covenant.
It is vital for a buyer to determine whether or not the restriction in question will interfere with their proposed use and enjoyment of the property. By the same token, it is essential for the seller to determine whether the restriction limits their ability to market and sell the property and ensure that they have appropriately disclosed such restrictions.
In addition, the supervising entity should confirm whether or not the property is in compliance during the due diligence process in order to ensure that the buyer does not become liable for repairs, corrections, or penalties resulting from the seller’s use or actions.
Our team is here to naviagate all of these elements with you and your sellers and buyers. Let us know how we can help.