Definition of Encumbrance and Encumbrances in Real Estate
Understanding the Role of Encumbrances in Real Estate
An encumbrance, as it pertains to real estate, means any legal thing that burdens or restricts usage or transfer of the property. A property free-and-clear of any encumbrances is rare. An encumbrance can be a mortgage (loan), a lien (voluntary or involuntary), an easement, or a restriction that limits the transfer of title. An encumbrance can involve money, but not always.
Deed of Trust or Mortgage as an Encumbrance
A lot of people wrongly assume an encumbrance refers only to a mortgage, because that is the more common usage. When a homebuyer finances the purchase of a home, that financial verification typically consists of two documents: the promissory note, which is an obligation to pay, and the mortgage or deed of trust, which secures the note and is recorded. A mortgage is slightly different than a deed of trust, but both are an encumbrance.
When a mortgage or deed of trust has been paid off, the encumbrance is then removed from the property in the public records. A common document to remove an encumbrance is called a reconveyance deed, which reconveys clear title to the property owner.
Trouble happens when the liability for a mortgage or deed of trust has been discharged through a bankruptcy hearing, but the loan is never formally released from the property. Not all bankruptcy lawyers practice real estate and some are unaware that a bankruptcy Chapter 7, for instance, does not release the debt or, their clients do not want to pay an additional fee to obtain a release of this encumbrance. This oversight can cause a cloud on title if the encumbrance is not released.
Voluntary Liens as an Encumbrance
A voluntary lien is a document that an owner willingly signs and generally it is recorded against the property in the public records. It could be a lien in exchange for money changing hands, such as a second loan or a home equity line of credit, or even a refinance of existing secondary financing.
In some cases, such as a line of credit, there might be no exchange of money until the homeowner actually taps the line of credit and borrows money. When interest rates are low, homeowners might take out a line of credit as an emergency source of funds. Even if the account is closed without ever being used, the homeowners must still record a release of the lien.
Involuntary Liens as an Encumbrance
Two fairly common types of involuntary liens are a lis pendens and a mechanic's lien. By involuntary, it means the homeowner did not necessarily agree that such a lien can be filed against the property but a lien nonetheless appeared. Lis pendens is a fancy way of saying pending legal action. Say, for example, that a seller agreed to sell to a buyer but the buyer, for whatever reason, could not close on time. So the seller canceled the contract unilaterally, without the buyer's consent.
To further complicate the matter, let's say the seller desired to sell to another buyer for more money and refused to extend the time to close for the existing buyer. The existing buyer, to prevent the seller from transferring title to the new buyer, might file a court action against the seller and record a lis pendens. The lis pendens would prohibit the sale until the court action was resolved.
A mechanic's lien is generally filed by a contractor or the contractor's sub-contractors for work or materials that remain unpaid. All involuntary liens must be paid off for a title company to issue a title policy without naming the encumbrances as exceptions to the title insurance. Involuntary encumbrances remain with the property until released. Further, the buyer's new lender will also require clear title.
Easements as an Encumbrance
Probably the most common type of easement is an easement for maintenance of utilities. An easement could also be granted for access (right of way) to a parcel of land that is landlocked without a road. Easements are an encumbrance because they prohibit certain actions and affect rights to the property. For example, you cannot build a swimming pool over a location reserved for a city sewer line. If you do, the city can dig up the swimming pool without your permission.
Easements are noted in your title insurance policy and often appear on the assessor's map itself.