Key takeaways: 

• A lien is a legal claim on an asset, not the asset itself

• How liens are different from collateral 
  

• Liens are necessary for many loans 

• How a lien gets removed  

Have you ever heard the term “lien” and wondered what it meant for your home, your car, or even your business? Liens can sound a little complicated and intimidating, leaving many people unsure about how they work and what they are used for. Why is a lien being placed on your property? Why does a lender require one for a business loan? This blog will explain what they are, why they are necessary and how they can affect your business.  We’ll provide a clear, easy-to-understand breakdown so you can feel confident and informed.  

What is a lien?

A lien is essentially a legal claim on a person’s property such as a house or a car, that acts as a guarantee that debt will be paid. Think of a lien as a “hold” on your property until you’ve fulfilled your financial obligation.  

How is a lien different from collateral?

There is often a lot of confusion on how a lien is different from collateral. Think of collateral as the “what” and a lien as the “how”. For example, when you take out a mortgage, the house you are buying is the collateral. The purpose of collateral is to provide the lender with a safety net to help reduce the risk of the loan. Collateral is just the property that the lender can take if the borrower fails to repay the debt. 

More specifically, a lien is the legal right that the lender can claim and sell the collateral if the loan isn’t repaid. It is just the legal mechanism that connects the debt to the specific asset. 

4 reasons liens are necessary for your loan

A lien is not just defense for the lender; it is super impactful for the borrower as well. Here’s why it’s so important for both the lender and the borrower: 

1. It Reduces Risk for the Lender Liens help protect the lender’s investment with a legal claim to collateral. The lender (at most times, a bank) is more confident in its ability to recoup its funds if the loan doesn’t get repaid. This reduced risk is why lenders will offer higher loan amounts and more favorable terms. 
2. It Makes the Loan Possible Without the security of a lien, many loans (especially larger ones for things like real estate or equipment) would be way too risky for a bank to approve. The lien is the open door for you to get the financing you need.  
3. It Can Help Lower Your Interest Rate When there is less risk for a loan, banks are often able to offer lower interest rates since there is less of a chance for the loan to default, saving you money over the life of the loan.  
4. SBA Requirements With loans over $350,000 that are not fully secured, the SBA requires lenders to evaluate taking a lien on personal real estate if the business assets are not enough to cover the loan amount.
   
   

Understanding the different types of liens 

While all liens have the same purpose, they fall into two important categories: voluntary and involuntary. Knowing the difference between the two is crucial as a business owner.  

Voluntary Liens: The Liens You Choose

A voluntary lien is a legal claim on a property as collateral for the loan that is put in place with the property owner’s consent. For a business, this can help the borrower secure financing at a lower interest rate and free up some working capital since the lien reduces the lender’s risk.  

Examples in business:

• Real Estate Mortgage When a business takes out a loan to purchase an office building or a warehouse, the lender will place a mortgage lien on the property. If the business fails to pay back the loan amount, the lender has the right to foreclose on and sell the property to recover their funds. 

•  Equipment Financing A company might get a loan to buy a large piece of machinery, like a printing press or a construction vehicle. The lender will file a UCC-1 financing statement (or PMSI – Purchase-Money Security Interest) which serves as a lien on that specific piece of equipment financed. If the company fails to make payments, the lender can repossess the equipment. 

• Vehicle Loan Like a car loan for a person, a business loan to purchase a company car or a fleet of trucks would involve a lien on the vehicle's title. The lien remains in place until the loan is paid off. 

• Blanket Lien A lender typically places a blanket lien on all a business's assets - including inventory, accounts receivable and equipment as collateral for a loan. This is common in a line of credit or a large term loan, where the business needs significant working capital and doesn't have a single, high-value asset to use as collateral. 

Involuntary Liens: The Liens You Want to Avoid

An involuntary lien is a legal claim on a property imposed without the owner’s consent, typically due to unpaid debts or obligations. These liens come to fruition from legal proceedings, court judgements, or statutory requirements, rather than voluntary agreements such as a home mortgage. For example, if a property owner fails to pay property taxes, the government can impose a lien on the property. Similarly, a lien can be placed on both business (real) property and personal property for unpaid work, materials or services by a contractor – known as a contractor lien (or mechanic’s lien). This is separate from lender’s lien.  

An involuntary lien can have a negative impact on your business. It can damage credit, create hindrance to what your businesses can and can’t sell. These often precede more serious legal action such as court ordered seizures to satisfy the outstanding debt.  

How to get rid of a lien

For voluntary liens, this is a very straightforward process. The lien will automatically be released once the debt is completely paid off. Once the debt has been paid, the bank associated with your loan will you send a lien release document that you or the bank will file with the county. Additionally, a lien can also be partially released through a loan modification, or you can swap the collateral for a different asset.

Partial Release Imagine you have a loan for a large piece of land and the bank’s lien is on the whole property. If you want to sell just a small part of that land, you can’t because the bank has a claim on it. A partial release is a loan modification where the bank agrees to let go of its claim on just that one section of land so you can then sell it. The bank would typically be okay with this because the rest of the land you own is valuable enough to cover the loan or would require a full/partial payment of the loan balance.  

Collateral Swap Imagine you have a loan for a car and the bank has a lien on the car’s title. You really want to sell that car and use a different car you own as security for the loan instead. A collateral swap (we call this substitution of collateral) is a loan modification where you trade one item for another. You and the bank agree to remove the lien from the first car and put a new lien on the second car. The bank agrees since the new car is just as valuable as the old car, so their loan is still protected. 

To satisfy an involuntary lien, the underlying debt needs to be paid off.  Once the debt has been paid off, the lender is legally obligated to file a lien release. 

Understanding what a lien is and why it is important is a crucial part of fully understanding the nuances of your loan. By staying informed and being proactive about your financial health, you can ensure your business assets work for you, not against you. Ready to explore your financing options? Our Team at Live Oak Bank is here to help you understand every step of the process. Contact us at liveoak.bank to get the conversation started.  

FAQs  

Q: Can a lien be placed on my business? 

A: Yes, a lien can be placed on a business and its assets. This is called a blanket lien. This often happens as part of a voluntary agreement to secure a business loan where a lender can place a lien on assets like equipment, inventory, accounts receivable, etc.    

Q: What is the purpose of a lien search?  

A: A lien search is to find out if there are any outstanding liens on a property or an asset before you buy it. This is critical to protect a buyer from unknowingly taking on the seller’s debts.  

Q: How do I dispute a lien?  

A: If a lien has been placed on your property or assets incorrectly, you can legally dispute it. The first step is to contact the lender who filed the lien and request proof of the debt. However, it's highly recommended to consult with a legal professional who specializes in property law to guide you through the process, as disputing a lien can be a complex legal matter.   

Q: Can having an existing lien prevent me from getting another loan? 

A: Yes, a lien can definitely make it harder to get another loan. Lenders perform a lien search during the underwriting process to see if any assets you're offering as collateral already have a claim against them.