What Is a Lien and How Does It Affect My Property?

A lien is a property right held by a creditor to secure the creditor’s right to payment from the borrower. Once the creditor is paid in full, the lien is released and the borrower owns the property free and clear. This article will provide an overview of the different types of liens, how they arise, and provide some guidance and additional resources on how to deal with liens in a Chapter 7 bankruptcy.

3 Different Types of Liens

There are three ways a creditor can obtain a lien against your property. You can voluntarily grant the lien as part of a purchase transaction, the lien is automatic under applicable state or federal law, or the lien is the result of a judgment for non-payment entered against the borrower, also called a non-consensual lien. Let’s take a closer look at each type.

Voluntary Liens

There are two types of voluntary liens. Purchase money security interests (PMSI) and non-PMSI liens.

PMSI Liens

A purchase money security interest (PMSI) is one where the finance company takes a security interest in the item you are purchasing. Examples of these PMSI liens include car loans and mortgages. When a lender finances the purchase of a car for you, they take a collateral interest in that car. If you don't pay them for the car, they can repossess the car because you have put it up as collateral for the car loan. Mortgages work the same way. If you don't make your house payment, the mortgage company can foreclose on the collateral. Since the collateral is your house, this means you'll have to move following the foreclosure.

Non-Possessory Non-PMSI Liens

A non-possessory non-PMSI lien is when you use property that you already own as collateral for a loan. If you have already paid off your car loan, you could put that car up as collateral for a new loan. This would not be a purchase money security interest (PMSI) since you have already purchased the car and paid off that loan. The loan is non-possessory if you have possession of the collateral instead of the lender. The possessory version of a non-PMSI is called a pawn. Pawns are under a different set of rules depending on your state's law and the rulings of the courts where you live.

Consensual Liens and Exemptions

Whether the lien is PMSI or non-PMSI, it is a consensual lien because the borrower voluntarily gave the creditor the security interest. As a result, the law treats these liens differently when it comes to exemptions. Unlike non-consensual liens, which can be eliminated if there is no non-exempt equity for them to attach to, consensual liens do take priority over exemptions. In other words, you can’t give a creditor a voluntary lien on property and then try to get out of paying for the debt that secures the lien by claiming an exemption. 

Statutory Liens

Statutory liens arise automatically - by operation of law. This type of lien is not a consensual lien. These include liens like mechanic's liens, liens by homeowner's associations, or tax liens. As soon as payment is due, the liens arise until you pay the debt. With federal tax liens, the lien arises when the tax is assessed. If you fail to pay, the IRS will send you a notice of federal tax lien. The IRS will also record the lien notice in your county recording office and possibly with your state's Secretary of State. Tax difficulties most commonly arise from earned income credit (EIC) situations, independent contractors, and small businesses. A type of surprise lien that may occur for the owner of a small business that is incorporated is the trust fund recovery penalty. With this penalty, the owner of the corporation discovers that they are personally liable for a corporate debt when they learn the IRS has a lien against them.

Different types of statutory liens may attach to different types of property. With a mechanic's lien, the lien attaches to the car you had repaired. Property liens such as homeowner's association assessment lien or a property tax lien attaches to your home or other real property. With a tax lien, the lien attaches to all property that you have. In the case of a federal tax lien, the IRS has to approve any sale of an asset covered by the lien. The buyer pays the IRS up to the amount of the tax lien for the property you sell.

Judgment Lien

A judgment lien arises when a creditor sues you and gets a judgment against you. These are involuntary liens. The creditor can be a voluntary or involuntary creditor. A voluntary creditor is one that you owe money to and they sued you to get a judgment due to your failure to honor the contract you had with that creditor. An involuntary creditor is not based on a contract, but a tort. If you have a wreck and it's your fault, the other driver may sue you. If that driver gets a judgment against you, they have a judgment based on a tort instead of a contract, but they still have a judgment against you. Like a tax lien, a judgment needs to be recorded to be an enforceable lien against a buyer. The judgment does not have to be recorded to garnish your wages. Judgments are recorded in the same county offices as notices of federal tax liens. Like a federal tax lien, these judgment liens attach to all your property including personal property and real property.

How Do You Find Out if There Is a Lien on Your Property?

Before a property owner sells any real estate (land, home, or building), the buyer must perform a title search with the county recorder's office. Different states use different terms for this office. These offices are sometimes called probate records, register of deeds, or even chancery clerk's recording office. While the names vary depending on the state, every county (or parish) in America has a recording office. Title insurance companies require a title search. The title searcher may find that your land is encumbered by a tax lien, judgment lien, or some other interest. You will be required to pay off these lien holders before selling or as is often the case, the lienholder will take their part out of the proceeds of the sale.

To determine if there is a lien on a car, look at the car's title. In some states, you can enter the car's VIN number into a computer to see if the car has a lien on it.

How Liens Are Treated in Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy, you may surrender the collateral for purchase money security interest liens and non-PMSI liens. This is different than if you surrender a car while not in bankruptcy. When you surrender your car to a lender, outside of bankruptcy, the lender treats the surrender the same as a repossession. Such a surrender is sometimes referred to as “letting the car go back.” Once a lender repossesses a car, they sell the car at an auction. If the car doesn't sell for enough to pay the debt you owe, the car loan company will sue you for the difference in what the car sold for at auction and what you owed on the car. Such lawsuits are very common after an auction. They’re not an issue for repossessions that occur after a bankruptcy has been filed, as the discharge eliminates the filer’s liability on the debt. 

In Chapter 7 bankruptcies, you may decide to keep the collateral. In this case, you will reaffirm the debt. Reaffirmation has the effect of treating the purchase money security interest as if it had not been part of the Chapter 7 bankruptcy. 

Many liens can be avoided in bankruptcy. Avoid is a term of art that means either eliminated or reduced. With a judgment lien, a motion to avoid eliminates the lien to the extent that there is no non-exempt equity for that lien to attach to. For example, if you have zero non-exempt equity in all your property for the lien to attach to, a motion to avoid eliminates the judgment lien. If you only have $100.00 of non-exempt equity, the lien's value will be reduced to $100.00, assuming the judgment is for more than $100.00.

Conclusion

You have many options to handle a lien. Each of these options involves paying at least part of the debt underlying the lien or otherwise eliminating the underlying debt. If negotiation will not work, you may be able to use your bankruptcy rights to eliminate the debt secured by the lien. If you have a straightforward case, you may be eligible to use Upsolve's free tool to file a Chapter 7 bankruptcy.