Possessory vs. Nonpossessory Lien: An Overview

Possessory and nonpossessory liens are two types of liens—legal claims to an underlying asset set forth as collateral to secure a debt or other financial obligation. The main difference between these two liens lies in who holds the security. As suggested by its name, the asset used as collateral in a possessory lien is held by the lender until the debtor fulfills their financial obligation and pays off the debt. In a nonpossessory lien, however, the collateral is not held by the lender. Instead, the borrower is usually the one who holds the security while the loan is in repayment.

Key Takeaways

  • Possessory and nonpossessory liens are legal claims to an underlying asset that secures a debt or other financial obligation.
  • With a possessory lien, the lender holds onto the underlying collateral during the term of the loan or agreement until it's paid off in full.
  • Nonpossessory liens give the borrower physical possession of the asset during repayment.
  • Pawnbrokers commonly hold possessory liens, while mortgages and car loans are common forms of nonpossessory liens.

Possessory Lien

A possessory lien occurs when the lender retains physical possession of the underlying collateral during the term of the loan or agreement. The lender has the legal right to retain the collateral until the obligation is retired or other conditions are satisfied. Once the terms of the agreement are met, the debtor can take possession of the asset.

While a possessory lien may eventually be used to claim legal ownership of the collateral—as in the case of default—a lien on an asset or piece of property does not grant ownership despite the lender retaining possession of the collateral. The possessory lien is still a contingent claim on ownership encumbering the asset. The borrower legally owns the collateral unless there's a legal reason for the lender to claim ownership under the lien.

Possessory liens may also be held by entities other than traditional lenders such as the government for tax payments. A pawnbroker is a common example of an instance where a possessory lien is part of the transaction. An individual may give personal jewelry to a pawnbroker in exchange for a loan. While still owned by the borrower, the jewelry acts as collateral and remains in the possession of the pawnbroker until the loan has been successfully repaid.

Another type of possessory lien is a garagemen's lien. In this case, a private property owner who rents the space out as a garage can take possession of a vehicle if the owner hasn't paid for a specified period of time. Towing companies also hold informal possessory liens. Once a vehicle is towed, the company can hold it until the owner claims and pays to have it released.

Liens are attached to a piece of property—not to the lender or borrower.

Nonpossessory Lien

Nonpossessory liens are much more common for consumers in the United States. These liens allow the borrower the right to retain possession of the collateral securing a loan or obligation. While the debtor has physical possession of the asset, the lender's name appears on the title for the collateral. If the borrower doesn't fulfill their financial obligation and defaults, the lender can take possession of the security.

A mortgage is one of the most common types of loans that use nonpossessory liens. When the lender approves a mortgage, the borrower can take possession of the home or property after the real estate deal closes. Although the homeowner possesses and lives in the home—or rents it out in the case of an investment property—the lender remains a lienholder until the loan is paid in full. If the borrower defaults, the bank can begin foreclosure proceedings, evict the resident(s), and repossess the property.

Automobile loans also involve nonpossessory liens. Just like a mortgage, the owner holds possession of the vehicle, while the financial institution that issues the loan retains the title. This allows the lender the ability to take possession of the vehicle in case of default. If, on the other hand, the loan is paid off without a hitch, the bank's name is removed from the title, giving the owner full claim against the asset.