A lien is a claim that one person or entity has over the property of another as security for the payment of a debt. Liens can be either voluntary or involuntary. A voluntary lien is contractual or consensual, meaning that the lien is created by an action taken by the debtor, such as a borrower who obtains a mortgage to buy a home and agrees that the home will serve as collateral for the loan. In contrast, an involuntary lien is imposed on the debtor by, for example, a court of law, without their say-so.
Key Takeaways
- Voluntary liens are consensual liens often used as a way to secure financing.
- For example, you might agree to a voluntary lien to obtain a mortgage to buy a home. In that case, the lender will have a lien on the home.
- When the lender has a lien on an asset, it can seize that asset if you fail to pay according to the terms of the loan.
- An involuntary lien is one that is imposed on you, such as a tax assessment lien imposed by the government.
How Voluntary Liens Work
A lien is a legal claim to an asset under certain conditions. A voluntary lien is a type of lien that exists because you agreed to it, or as a result of an action taken by you. In contrast, an involuntary lien is one imposed by law, such as a tax lien that is initiated by the government for failure to pay taxes. When there is a lien against your property, you cannot legally sell it until you settle the amount you owe.
Liens apply to specific property, not to you personally. If you default on a debt, the lien holder can take possession of the property in question. For example, a lender can take your home if you default on a mortgage used to secure it or your car if you default on an auto loan.
How Voluntary Liens Are Applied
Voluntary liens are often used for mortgages to purchase real estate, but they can also be used in many other types of financing, such as car loans, secured personal loans, business loans, credit agreements, and even rent-to-own appliance transactions.
Typically, the physical property that the borrower is purchasing acts as collateral under the lien. However, a voluntary lien can also be placed on other property that the borrower already owns if the borrower agrees to it. For instance, a lien could be placed on a valuable painting if the borrower uses it as collateral for a cash advance to fund another purchase.
Or, a homeowner who has paid off their mortgage and owns their house outright might need more cash and allow a lien on it to obtain a home equity line of credit (HELOC). Just as with a mortgage for a home purchase, the house would serve as collateral.
Finally, a business could have a voluntary lien on it if the business owner takes out a line of credit to cover operating expenses or other costs. In this case, the lender would not take possession of the business if the borrower defaults but instead receive a security interest in it.
Voluntary Liens vs. Involuntary Liens
An involuntary lien, or a nonconsensual lien, is one that is imposed on you instead of one you consent to. Two types of involuntary liens are statutory liens and judgment liens.
When the law gives a creditor the right to impose a claim on your property for an unpaid debt, that is a statutory lien. One common type of statutory lien is a tax lien, in which the government has the right to seize your property if you fail to pay a tax bill.
A judgment lien occurs when a court rules that a lien should be placed on your property to satisfy your obligations to creditors. For example, if your insurance does not cover all of the damages you are responsible for in an accident, a court might impose a judgment lien.
Does a Voluntary Lien Affect Your Credit?
When you have a voluntary, or consensual, lien against your property, your credit score will not be affected as long as you abide by the loan terms, such as continuing to make the required payments on time. However, other potential creditors can be aware of the lien, so you won’t be able to use that particular asset as collateral for additional loans.
Do Statutory or Judgment Liens Affect Your Credit?
Involuntary liens can negatively affect your credit. Liens don’t appear on your credit report, but they are available through public records, so potential lenders can learn about them. Additionally, if the lien resulted from your failure to pay a bank or real estate loan, those missed payments will be reflected on your credit report, which can cause significant damage to your credit score. Your payment history is the single most important factor that credit scoring models, such as FICO, use in assigning you a score.
What Is a Statutory Lien?
A statutory lien is one that is a result of the existing law, and doesn’t require your consent or a court judgment against you. It can be used by creditors in an attempt to collect unsatisfied debts.
What Is a Judgment Lien?
A judgment lien is a type of involuntary lien imposed on your property due to a court order. Judgment liens are typically issued after a creditor sues a debtor for an unpaid debt or other obligation and wins their case.
The Bottom Line
Voluntary liens are common in many financial transactions and, unlike involuntary liens, will have no negative impact on your credit as long as you keep up with your loan obligations. However, they do put your property at risk if you are unable to repay, so you’ll want to consider that possibility before you consent to one.
Related Terms: lien, mortgage, home equity line of credit, judgment lien, statutory lien, credit score, asset.
References
- Internal Revenue Service (IRS). “Understanding a Federal Tax Lien”.
- State of California, Franchise Tax Board. “Liens”.
- Maryland Courts. “Judgments & Debt Collection”.
- Experian. “What Is a Lien and How Does It Work?”
