Every real estate investor should take the time to understand property liens. A good example of why a working knowledge of property liens and how they affect your investment is so critical would be with the purchase of auction properties. A winning bid and purchase of an auction property does not remove an IRS tax lien so if you do not know how to check for liens on a target property you just might acquire a tax bill in addition to deed to the property.
Liens are simply a legal claim against a property. Liens encumber title to a property, which could prevent the owner from borrowing against or selling it. The most common type of property lien is a mortgage (or trust deed) for a loan (or note) with the property as collateral.
This type of lien is “voluntary” and the property is “security” for the loan. The lien allows for the lender to foreclose on the property if the loan is not repaid.
Involuntary liens are placed on properties by other parties for unpaid obligations. Most people have heard of a tax lien, an example being if you don’t pay your county property tax bills for a period of time the county will foreclose on your property. Other examples of involuntary liens include:
Construction lien – a claim created by trades people, contractors, architects and material suppliers who perform services on a construction project
Mechanics lien – a claim created by a contractor or supplier who performs work or provides materials on an improvement project
Judgement lien – a claim created when a court grants a creditor interest in a debtor’s property
IRS tax lien – where the IRS places a federal tax lien on a taxpayer’s property
Other potential liens – unpaid utilities, HOA dues, child support payments, etc.
In some municipalities it is a simple and easy process to place a lien on a property, even if it is frivolous. Removing a frivolous lien can be a time-consuming job. Worse is an undiscovered lien that can cause a “cloud” over the property and cause a legal headache after a sale.
Another important concept regarding liens is “lien priority.” Lien priority becomes important when there is more the one lien on a property and determines who gets paid off first.
If you assume it is always the first lien that gets paid off first you may be wrong, depending on where the property is located. There are some municipalities where certain kinds of “statutory” liens (such as a mechanic lien) have favored priority.
Most investors recognize the importance of searching for liens on a target property and make it a major part of their due diligence process.
A property lien search can typically be done at the county or city assessor’s office or on their online site. Many investors maintain a close relationship with a title company who can perform lien searches on properties they are investigating. When a property is under contract to be sold, it is pro forma for a title company to run title searches. They will then offer a title commitment that guarantees discovery of all liens on the property and ensure all liens will be “cleared” at the time of closing.
The most common way liens are removed is to pay them. This is why you see at any closing the existing loans on the property listed on the HUD settlement statement as a debt to be paid from escrow before any funds are released to the seller. The title company will record this transaction with the county and the lien will be satisfied. Sometimes it may be necessary to ask the title company to perform a “quiet title action” when there are defects or mistakes creating clouds over the title. It can take time for the title company to go through this process, meanwhile, the investor must wait for “clear title” before selling or refinancing the investment.
It is always a good idea to obtain a lien waiver from all contractors at the end of any rehab work done on the property – this will prevent them from putting a frivolous lien on your investment property to make sure you have marketable title.
You can see why understanding the legal mechanism of the property lien is an important part of the real estate investor skill set and knowing how to search for them is critical to the due diligence process and to success in real estate investing.