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A lien is a legal tool creditors use to stake a claim to an asset you're using as debt collateral. Liens are used as a backup to help safeguard lenders' investments, but can also be used as a remedy for creditors to collect unsatisfied debts.
Read on to learn how they work and the differences between the different types of liens.
How Does a Lien Work?
When you offer collateral for a loan, the lender requires a guarantee that it can seize the property to recoup its loss if you default on your debt. A lien is the legal claim that helps creditors do this.
There are two main types of liens: consensual and involuntary. Consensual liens are ones you agree to, like what happens when you get a mortgage or car loan. Involuntary liens are those filed due to nonpayment of a debt, commonly when taxes go unpaid or payments on a loan become delinquent.
To understand how consensual liens work, consider your mortgage. When you buy a home with a mortgage, the lender retains the right to seize the home to recoup what they're owed until the loan is completely paid back. This legal claim is done through a mortgage lien that gets removed once you've paid off the debt.
An involuntary lien, on the other hand, is one filed by a creditor in pursuit of outstanding debt. Involuntary liens are typically placed on your assets by a court; they give a creditor legal claim to what they're owed and can result in foreclosure if they go unpaid.
Involuntary and consensual liens do essentially the same thing, but the difference is involuntary liens are considered derogatory as they are a result of nonpayment. Consensual liens—like your mortgage or auto loan—are just a side effect of borrowing, as they provide an avenue through which a debt can be collected if you default on your obligation.
What Are the Different Types of Liens?
There are several types of liens that can be filed against you. As mentioned, some liens are voluntary, and others don't require your consent because they're filed by a creditor as a result of nonpayment.
The following are the different lien types and the circumstance around how each are established:
- Real estate lien: A real estate lien is one that gives a creditor the right to seize and sell real estate property if someone defaults on an agreement. Mortgages are common real estate liens, and are an example of a voluntary lien that you agree to when you borrow money to buy a home.
Additional liens can be placed against your real property, which can be both voluntary and involuntary. If you take out a second mortgage on your home, or use your home equity as collateral for another loan, a second (or third) lien would be recorded against that property. The lienholders (the creditors) in this case would be given priority based on when the lien was filed. Lien priority comes into play when you sell your home and also dictates who gets paid first if the property is ever liquidated or foreclosed.
- Tax lien: A tax lien is an involuntary lien that is placed on your property if you fail to pay state or federal taxes. Tax liens are given priority over all other liens, which means they must be paid first. Federal and state tax liens can be placed on assets including personal property. When left unpaid for extended periods of time, tax liens could result in the forced sale of your property, at which time all or some of the additional lienholders would be paid what they are owed from the proceeds of the sale.
- Judgment lien: A judgment lien is placed on your property or assets by a court that establishes you have an outstanding debt. Creditors that can prove you defaulted on an agreement and owe them money can file judgment liens in local courts. As with other liens, if your property is sold the lienholders will be paid from the proceeds of the sale.
- Mechanic or construction lien: Liens of this type must be filed through court and are placed against real property for which a contractor or subcontractor has performed work and was not paid by the property owner. A construction or mechanic lien can only be placed on the property the creditor worked on.
What Happens if I Don't Pay a Lien?
If a debt obligation goes unpaid for long enough, you risk losing the property the lien applies to. An unpaid mortgage lien, for instance, can result in foreclosure if you do not satisfy the outstanding debts. Once paid, individual liens will be removed from your property. If left unpaid, creditors can choose to move forward with a foreclosure, which would force the sale of the property and pay all lienholders from the proceeds of the sale (if there is enough to satisfy all of the lien amounts).
In many cases, non-mortgage lien foreclosures are rare, but still possible. In most scenarios, the creditor who filed the lien will have to wait until you sell the home or refinance, at which point the lienholders will be entitled to what they are owed.
It's possible, however, that a foreclosure won't fully cover all outstanding debts. Any creditors still owed after the foreclosure process may still go after outstanding balances, and liens can be transferred to other property, or property the debtor owns in the future.
Does a Lien Show Up on Your Experian Credit Report?
Since 2018, tax, judgment and mechanic liens haven't been included on the credit reports maintained at the three consumer credit bureaus (Experian, TransUnion and Equifax). In the case of real estate liens, the lien itself isn't recorded in your reports, but the mortgage for which the lien is held is listed as one of your credit accounts.
Currently, the only public records listed in credit reports are bankruptcies. Records of Chapter 13 bankruptcy remain in credit reports for seven years from the filing date; records of Chapter 7 bankruptcy remain in reports for 10 years from the filing date.
What Can Negatively Impact Your Credit
Though liens themselves are not included in your reports, if the lien was involuntarily, it's likely due to nonpayment. In that case, if the creditor that filed the lien reports payment information to the credit bureaus, a record of nonpayment could be listed in your reports and negatively impact your scores.
Here are some of the main score factors that you should monitor when working to maintain a good score:
- Maintain a good payment history. Making on-time payments is the most important thing you can do to maintain or improve your credit score. Even one late or missed payment can cause your score to drop, so make sure to pay all your bills on time to avoid any negative impact.
- Keep your credit card balances low. Credit utilization is another important aspect of your credit. Credit scores can suffer when your credit balance approaches or exceeds 30% of your credit limit; maxing out your credit cards could put a big dent in your scores. Those with the best credit scores tend to keep their credit utilization in the low single digits.
- Keep a good credit mix. Lenders might want to know how you've handled various types of debt (credit cards as well as installment loans, for instance). Which means a diversified credit report that includes different types of credit can help your scores.