An encumbrance in real estate means someone besides the owner has a claim on the property. If you plan to count the real estate as an asset, you need to know what encumbrances could affect the value. The seller must disclose all encumbrances before the sale, and although some of them are the seller's responsibility, others may not be. Examine encumbrances on any real estate asset to make sure you understand its true value.
In real estate, an encumbrance means that a person, other than the owner of the property, has a claim on the property.
Understanding the Basics of Mortgages
A mortgage is an encumbrance. The owner of the property has pledged the property itself as collateral for the mortgage, and the lender has the right to foreclose on the property if mortgage payments aren't made. While this obligation falls on the owner and not on the buyer, a buyer should ask if mortgage payments are current. A lender could be considering a foreclosure that would stop the sale of the property.
Evaluating Contractor Liens
If a property owner fails to pay a contractor for repairs or remodeling, that contractor can place a lien on the property. This means that when the property sells, the contractor gets paid out of the proceeds. The owner must pay these liens, but you must insist that such payments be included in the purchasing contract. It's important to remember that the liens are on the property and not the owner, so a contractor could come after you if the owner fails to pay at the time the property sells.
Assessing Tax Liens
A federal, state, county or city taxing agency can place a lien on a property for back taxes. These agencies take first position, meaning the taxes must absolutely be paid when the property sells. Make sure your contract specifies that the seller will pay off any tax liens when you buy the property, or you could be strapped with a tax liability the moment the real estate becomes yours.
The taxes are always back taxes, so make sure the seller has not raised the selling price to pay off taxes that should have been paid long ago. If you pay a higher price because of back taxes, this means that you are paying the tax instead of the seller.
Exploring the Impact of Lawsuits
A court can place an encumbrance on a property to satisfy a lawsuit. In other words, you could end up buying the property, then giving it to the plaintiff in a case. The court judgment would take precedence over your rights as a buyer, and you would have to sue the seller to get your money back.
This can cause problems when a lawsuit is pending and the seller does not disclose it. A pending lawsuit may not have an encumbrance in place yet, but the suit would still outweigh your rights as a buyer.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.