What is a lien?

When it comes to homeownership, there's an important financial term that may come up during your conversations: a lien. Maybe, you're asking, "what is a lien?" Perhaps the idea of one is even scary to you. Fortunately, understanding this financial tool can be the beginning of being better prepared for the personal finance decisions you may need to make down the road. Here’s what you need to know about the different types of liens and how they affect you.

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What is a lien?

If you borrow money, and the debt is attached to a piece of property, such as a house, then there is a lien against that property. It gives the lender a claim to your property for the duration of the debt. Unpaid debts may result in the property being taken by the lender as a fulfillment of the debt.

Liens can be taken against any type of property, from houses to cars to land. Any debt that is secured by tangible property may be subject to a lien.

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How does a lien work?

You may have heard that someone has a lien against their home. While this may seem like a bad thing, it’s actually pretty common. In fact, a mortgage is a type of loan that includes a lien. If you don’t pay on your home loan, the lender can take your home to help recover the debt.

Without a lien, you would be expected to pay off the entire home purchase price right away. Most people can't do that, which is where the mortgage (and the lien against your home by the bank) comes in. It's security that you will repay your home loan as promised.

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Is it bad to have a lien on your house?

Whether a lien on your home is good or bad depends on a few factors. Home mortgages are just one kind of lien. Typically, you would know about this lien when you applied for and accepted the terms of your mortgage. Most consumers generally agree that this is a good type of lien.

Not everyone knows about liens against property, however. There have been cases of people buying property and not having full disclosure that liens were still in place against their homes. This is where it pays to do research or have a professional look into your home’s history to be sure it has a clear title. Buying a home with liens attached leaves you responsible for repaying the debts. This is not something you want to happen.

Another “problem” lien is one that is taken out against your wishes. If you pay to have a home built or have significant repairs done on your home, but the building company isn’t paid on time, they may take out a lien against the home. This type of lien is often referred to as a “mechanic’s lien,” or a “builders lien.”  This can be bad because it may result in you owing money to both the lender and the home-builder – with each having liens in place. 

In Canada, the definition of a Mechanics Lien depends on the province where the lien is being registered.  Some provinces view Mechanics Liens as the same as Builders or Construction Lien.

The government can also put a lien against your home if you fail to pay property taxes. This type of lien prevents you from selling, refinancing, or giving away your property until you pay off your debt to the government, and they remove the lien. Unpaid revenue or income taxes may result in a lien, as well.

Similarly, in Canada, the CRA may put a tax lien on your property for unpaid tax debts.  They will not register the lien until they have tried, and failed, at other collection methods. CRA may also put a tax lien on your credit report.

In the US, homeowner’s associations (HOAs) may place liens on properties within their community if HOA fees remain past due after some time. Check the terms of your HOA agreement to see if this is a possibility; once a lien is placed by the HOA against your home, you risk losing your house to the community.

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What’s the difference between a first lien and a second one?

A first lien is the lien placed before any other on a piece of property. The second lien would have happened after the first, and it has a lower priority in the event that sales of the property are used to repay debts.

How does this work? Assume you take out a mortgage on your home, but then a home construction company does repair work that goes unpaid. That construction company may put a lien on your home to try to satisfy the debts. If the home ends up being foreclosed on, however, the first lien (mortgage) would be satisfied from the sale proceeds before the second lienholder gets any of the money.

Because it can be difficult, if not impossible, for the second lienholder to get their money, more than one lien isn't typically done on purpose. For example, you can't usually qualify for a line of credit on your home if you owe the full amount of your mortgage. If your home is already paid off or partially paid off, you have some equity to work with and may consider something like a home equity line of credit.

However, taking out a home equity line of credit (HELOC) results in a new lien. You would only be able to take out a loan for the equity portion (the part you paid off) since it represents the difference between what the mortgage company could try to claim and what the home is worth. This ensures that both the mortgage company and the line of credit lien holders could get their fair share in a foreclosure.

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How do liens impact my credit score?

Whether a lien will affect your credit depends on the cause of the lien. Mortgage liens and liens for home equity loans, for example, are treated like any other debt. Continue to repay it as promised, and don’t overextend your credit (borrowing too much of your credit line at once). Your credit score is affected by your use of that credit, even allowing you to build credit with responsible credit patterns over time.

On the other hand, liens may be a sign of a judgment against you, unpaid taxes, or past due debts on a construction loan. For a lien to be placed on your property, it’s possible that late payments. These actions will most likely be reported on your credit report and result in a lower credit score. In fact, foreclosures, which result in your lender using the lien to repossess your property, are one of the more damaging things on your credit history. Even if you manage to resolve the debt through better personal finance decisions, that past credit history can affect your credit score for a long time.

In the US,  while no longer reported to credit agencies, tax liens still need full payment for release. The IRS releases tax liens 30 days after payment in full. 

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What do I need to know about liens when tapping into my home equity?

Liens are often used when taking out a Home Equity Line of Credit (HELOC) or a reverse mortgage. The lender places a lien on your home until the loan is fully satisfied. Where these products differ is in their availability and flexibility. How does a reverse mortgage compare to a home equity loan? Reverse mortgages are generally available to those 65 and older only, and they may be subject to prepayment penalties. A Fraction Mortgage, however, is available to all ages with no prepayment fees for paying down your debts and removing the lien from your home.

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Fraction gives you a way to use your home’s equity in a way that’s flexible, so you can reach the personal finance goals that matter most to you.