What Is a Lien?

A lien is a claim or legal right against assets that are typically used as collateral to satisfy a debt. A lien could be established by a creditor or a legal judgement. A lien serves to guarantee an underlying obligation, such as the repayment of a loan. If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien. There are many types of liens that are used to secure assets.

Key Takeaways

  • A lien is a claim or legal right against assets that are typically used as collateral to satisfy a debt.
  • If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien.
  • Various types of liens can be established including by a creditor, legal judgement, or tax authority.
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Lien

How Liens Work

A lien provides a creditor with the legal right to seize and sell the collateral property or asset of a borrower who fails to meet the obligations of a loan or contract. The property that is the subject of a lien cannot be sold by the owner without the consent of the lien holder. A floating lien refers to a lien on inventory or other unfixed property.

Liens can be voluntary or consensual, such as a lien on a property for a loan. However, there are also involuntary or statutory liens whereby a creditor seeks legal action for nonpayment, and as a result, a lien is placed on assets including property and bank accounts.

Some liens are filed with the government to let the public know that the lienholder has an interest on the asset or property. A lien's public record tells anyone interested in purchasing the asset or collateral that the lien must be released before the asset can be sold.

Types of Liens

There are many types of liens and lien holders. Liens can be put in place by financial institutions, governments, and small businesses. Below are some of the most common liens.

Bank Lien

A lien is often granted when an individual takes out a loan from a bank to purchase an asset. For example, if an individual purchases a vehicle, the seller would be paid using the borrowed funds from the bank. In turn, the bank would be granted a lien on the vehicle. If the borrower does not repay the loan, the bank may execute the lien, seize the vehicle, and sell it to repay the loan. If the borrower does repay the loan in full, the lien holder (the bank) then releases the lien, and the individual owns the car free and clear of any liens.

Judgment Lien

A judgment lien is a lien placed on assets by the courts, which is usually as a result of a lawsuit. A judgement lien could help a defendant get paid back in a case of nonpayment by liquidating the accused assets.

Mechanic's Lien

A mechanic's lien can be attached to real property if the property owner fails to pay a contractor for services rendered. If the debtor never pays, the contractor could go to court and get a judgement against the non-paying party whereby property or assets can be auctioned off to pay the lien holder. Many service providers have the option to place a lien to secure payment, including construction companies and dry cleaners. 

Real Estate Lien

A real estate lien is a legal right to seize and sell real estate property if a contract is not fulfilled. Some real estate liens are automatically put in place, such as the case of a mortgage lien. When a party borrows money from a bank to purchase their home, the bank places a lien on the house until the mortgage is paid off. However, some real estate liens are due to non-payment to a creditor or financial institution and as a result, are involuntary and nonconsensual liens.

Tax Liens

There are also several statutory liens, meaning liens created by law, as opposed to those created by a contract. These liens are very common in the field of taxation, where laws often allow tax authorities to put liens on the property of delinquent taxpayers. For example, municipalities can use liens to recover unpaid property taxes.

In the United States, if a taxpayer becomes delinquent and does not demonstrate any indication of paying owed taxes, the Internal Revenue Service (IRS) may place a legal claim against a taxpayer's property, including the taxpayer's home, vehicle, and bank accounts. A federal tax lien has precedence over all other creditors' claims and can lead to a sheriff's sale. A sheriff’s sale is a public auction whereby assets are repossessed, sold, and the generated funds are used to repay a debt to a creditor, bank, or the IRS.

A tax lien also affects the taxpayer's ability to sell existing assets and to obtain credit. The only way to release a federal tax lien is to fully pay the tax owed or to reach a settlement with the IRS. The IRS has the authority to seize the assets of a taxpayer who ignores a tax lien. Typically, the IRS uses liens for delinquent taxes as a last resort following all other options being exhausted, such as collection, installment repayment plans, and settlement.