What is Lien in Banking? Understanding Types of Lien and Their Meaning

It is a common practice to finance high ticket expenditures with the help of a loan. This is generally true for expenditures, the benefits of which are expected to be reaped over the long term, such as financing the purchase of a house or car or setting up a new business.

Since the amount involved is huge and the repayment schedule is long-term, it is always wise to know the nuances and aspects of borrowing to make an informed decision. One such important aspect is Lien. So, what is ‘lien’, and how does it work? Let’s find out!

What is Lien?

A Lien is the creditor’s right over the asset used as collateral for securing payments on debts. A Lien can be established either through a creditor’s judgement or court order. Lenders or creditors have the legal right to seize the asset if the borrower fails to meet the terms of the underlying obligation, such as repayment of the loan.

Despite high-interest rates, collateral and liens are necessary for favourable loans to businesses, depending on their financial situation and collateral availability. A lien ensures that an underlying obligation will be met, such as loan repayment. This is because, in the event of nonpayment of the underlying obligation, the creditor has the right to seize the collateral and sell it to recover the lent amount.

How Does Lien Work?

Liens give creditors the legal right to seize or sell collateral when borrowers fail to meet their obligations on a loan or contract. Property subject to liens may not be sold without the lienholder’s consent. If the property is leased, a lien may be deposited voluntarily or with consent, for example, as part of an agreement to lend the property.

Nonpayment of a loan may result in an involuntary lien or statutory lien. An asset such as a property or a bank account will record a lien at the end of the process. Some liens are filed with the government to demonstrate a claim to assets or property held by the lien holder. The lien record informs anyone interested in purchasing an asset or collateral that the lien has to be released before the asset can be sold.

Say you acquire a lien on a property for business purposes. You could purchase the property from a dealer with a bank loan, and the bank would take title to it as well as hold a lien on it. In the event that the borrower defaults, the bank has the right to sell the property to recoup the loan amount. The bank owns the property as a security interest, so property ownership remains with them.

What is Lien in Banking?

It is a lien that accompanies the loan taken out by an individual to purchase an asset. For example, you take out a loan to buy a car. The amount you borrow will cover the price of the vehicle. By doing so, the bank becomes a lienholder on the car. In the event that you fail to repay the loan and interest, the bank could put the car into their possession. When the loan is paid off in due time, the lien is released and you become the rightful owner of the vehicle.

Types of Liens

Lienholders and liens come in various forms. Small businesses, governments, and financial institutions can put either a general lien in place or a specific one. Some common specific liens are mentioned below:

1. Tax Lien

There are several types of statutory liens, meaning liens created by law instead of through a contract. Statutory liens are commonly used in taxation liens since the government often levies taxes on delinquent taxpayers’ properties. Tax liens also interfere with the taxpayer’s ability to sell the property and obtain credit.

2. Judgement Lien

In the case of a non-payment, a judgement lien can help the creditors by liquidating the debtor’s assets to get paid back. Judgments are placed by the courts on assets as a result of lawsuits. In simple words, if a debtor fails to fulfil their contractual obligation, a court ruling gives creditors the right to seize their property.

3. Real Estate Lien

Some real estate liens are automatically placed, such as those resulting from mortgages. If a contract is not fulfilled, a real estate lien can be used to foreclose on the property and sell it. Liens on real estate are a type of legal remedy for the non-fulfilment of a contract. A mortgage lien is placed on a property as a result of a loan from a bank.

4. Mechanic’s Lien

A mechanic’s lien attaches to real estate when contractors aren’t paid for their services. In the event that a contractor is unable to collect from the debtor, a judgement could be obtained that would allow the lienholder to auction off assets to fulfil its obligation.

5. Attorney’s Lien

This refers to a lawyer’s right to hold a client’s property until the client has paid for legal services provided. This could be business records, official documents, or money awarded by a court. Lawyers are entitled to a lien either by common or state law.

Lien in Bankruptcy

Lien in banking plays an important role in figuring out bankruptcy. Lien is a form of security which is granted over a property to secure the repayment of the loan. If a person is not able to make the repayment of the loan, the debtor has the right to claim the property used as collateral for the loan, enabling the creditor to sell the property and use the proceeds as repayment of the loan. In simple words, a lien gives the creditor the right of possession of the property used as collateral for the loan until the loan has been repaid.

Under bankruptcy, the responsibility to repay a loan gets wiped off (such as car loan payment or mortgage) which also includes deficiency balance. However, the borrower will not be able to keep the property used as collateral until they pay off the debt. Here’s how a lien in bankruptcy works:

• Obligation to pay back the creditor: It is the responsibility of the borrower to pay off the entire debt. Bankruptcy may wipe out the liability of the personal debt assuming that it qualifies for the discharge. This way, the creditor will not be able to sue the borrower to collect the debt and will not be able to use the judicial lien to trim your wages or take money from the borrower’s bank account. 
• Creditor’s right to use collateral to recover the lent amount: Bankruptcy does not eliminate lien, so it becomes the right of the creditor to offset the amount that was borrowed by force selling the collateral used to obtain the loan.

Although the lien can be eliminated, it can be discharged in bankruptcy, which releases the liability of the debtor to pay off the debt. However, some liens do remain after the bankruptcy, and the same is the case with tax liens.

How to Remove a Property Lien?

There are several methods to do away with liens on a home or a property. One of them is to negotiate a settlement with the lienholder, but how it goes depends on the type of lien, the relationship between the debtor and the lienholder, and the value of the lien. A lien is linked to the asset that it is secured against, not the owner of that asset. For this reason, the holder of a lien can be freed of it when they sell the asset.

A lien on the property is a claim granted by a court to a creditor when a debtor does not pay their debt. The lien is filed with the local property registration office and notified to the property owner.

However, this option has its downsides. While they receive proceeds from the sale, the homeowner is expected to pay off the lienholder first. And they may have difficulty selling any property that has a lien. It may be prudent for prospective buyers to avoid a property possessed by someone else.

Once you have paid off a debt, you can file a Release of Lien, which serves as evidence that the debt has been repaid. One of the easiest ways to remove a lien is to satisfy it.

Conclusion

Debt forms an important part of one’s financial life. It often becomes necessary to fund heavy expenditures, which are important but unaffordable at times. However, since debt is an obligation, one must understand the intricacies surrounding it well, especially ‘lien’ . We hope the information shared above helps you understand what a lien is and how it can affect your financial well-being.