When considering buying a new property, you want all the relevant information possible — how old it is, what sort of maintenance work it needs, and whether someone is living in the basement. Not least among these considerations should be any encumbrances on the property.
Buyers and sellers alike should have a comprehensive understanding of what encumbrances are, what types of encumbrances exist, and how each one can affect the value and usability of a property. Not doing so can lead to some utterly unwelcome surprises later. So let’s take a look.
What Is an Encumbrance?
An encumbrance is a claim against a property by someone other than that property’s current owner. There are several types of encumbrances, all of which restrict either the owner’s use of the property or their ability to transfer it in some way.
Encumbrances can apply to personal property, but they are more common in use with real property.
While many real estate encumbrances surround financial obligations and arrangements, some, such as easements and zoning laws, are not financial.
Some encumbrances will have a minimal or even unnoticeable impact, such as a minor restriction on how owners may use a property. Others may restrict the title, encumbering the owner’s ability to sell or transfer the property and even giving third parties the right to repossess it under certain circumstances.
Encumbrances that impact real property are typically required to be part of the public records at the county recorder. This allows a title company, or other researcher to pull up any encumbrances that may be clouding the title.
7 Essential Types of Encumbrances
Various real estate encumbrances can affect a property, and most real estate carries at least some restriction. These encumbrances can be explicit agreements with sellers, creditors, lessees, neighbors, or various government and private entities. Others are undocumented and situational, while some derive from local or regional law.
1. Easements
An easement is an encumbrance that gives one or more parties the right to use an owner’s property for a specifically defined purpose.
For example, an easement may give a neighbor the right to use a parcel of the property owner’s land to protect the neighbor’s access to water, drainage, roads, or agricultural land.
Another common type of easement is a utility easement, which may give utility workers access to water, power, communication, gas, or drainage infrastructure on the owner’s property.
Eminent domain, the right by which governments in the US can forcibly purchase private land for public use, is also an easement.
Easement rights are tightly tied with the property itself. Therefore, individuals typically cannot alter them as part of a deal in selling or transferring a property.
2. Encroachments
An encroachment is a type of real estate encumbrance that is usually undocumented and potentially even unknown to the parties involved.
When a structure such as a fence, outbuilding, or tree crosses over a property line, it creates an encroachment. This encroachment is an encumbrance on both parties.
An encroachment is effectively like an easement with no official agreement or protection for either party.
The owner of the encroaching property has a structure or component of their property to which they do not hold a proper title. The owner of the property that is encroached upon has a potential limitation on access to their land, as there is something physically blocking it. Each of these constitutes an encumbrance until both parties resolve it.
Although an encroachment may be only a minor nuisance, it can also become quite burdensome and hurt the marketability of either property.
3. Leases
The grantor vs. grantee relationship between a lessor and lessee puts restrictions on both parties. For the tenant or lessee, a lease imposes restrictions on their use of the property, how long they may retain temporary property rights, and what they must offer in exchange, typically rent payments.
A lease is a form of encumbrance for the owner letting out the property. It protects the tenant by limiting how, when, and in what capacity the owner can use the property.
Active lease agreements play a role in the transferability of a property and may affect its market value either positively or negatively.
4. Legal Encumbrances
Legal encumbrances include any laws regulating the development and uses of a property. The most common of these include zoning laws and environmental regulations.
A legal encumbrance has no bearing on the transferability of a property. Like an easement, it will remain regardless of any deals or agreements between a purchaser and seller. The limitations here primarily affect what improvements an owner may build, whether and what type of business may be conducted onsite, and which building codes an owner must follow.
Rather than an explicit contractual encumbrance like a lease or a mortgage, legal encumbrances are more implicit. They primarily derive from local ordinances, state law, and any other relevant jurisdiction. The burden is on the home buyer to do their research and familiarize themselves with the applicable legal encumbrances on their new property.
5. Liens
Liens restrict the owner’s full access and transferability of a property title. A lienholder is a party with the right to seize the property from the owner if the owner fails to meet specific obligations.
A lienholder could be an organization, private person, or government entity. Their claim on the property could be pursuant to a variety of circumstances, including the owner’s:
- On-time tax filing and payment (tax liens)
- Ability to pay a debt (mortgages)
- Fair compensation of contractors and other parties who do work on the property (mechanic’s liens)
- Status as the defendant in a lawsuit
Some of these liens are standard arrangements that use the property as collateral in financial agreements. Others are punitive and typically come about as a result of legal problems, unpaid debts, or mismanagement on behalf of the owner. In any case, a lien can result in foreclosure for owners who do not cover their liabilities.
A common type of lien arrises from not paying property taxes. In this case, the county will file a lien against the property. This lets others know that if the tax is not paid, action will be taken to foreclose on the property by the government. Usually parcels with unpaid taxes end up at a tax lien sale.
6. Mortgages
One specific type of lien that warrants its own entry here is mortgages. These are one of the most common and recognizable types of encumbrances, as most homeowners have at least one.
Like most liens, a mortgage limits transferability and restricts the title to a property. A mortgage is an agreement that gives a creditor an interest in the property such that they have an avenue for recourse should the owner fail to repay their mortgage debt. Should that happen, the lender can foreclose on the property and repossess it as collateral.
7. Restrictive Covenants
A restrictive covenant is a unique type of encumbrance unlike many others on this list. It is neither a financial encumbrance nor an immutable standard for who can access the property. Instead, it is a binding agreement between a buyer and seller.
When selling a property, the seller can add a restrictive covenant as a clause into the deed that restricts the buyer’s use of the property.
For example, a restrictive covenant may limit the new owner’s ability to demolish part of a building or perform particular renovations. Agreements like these preserve the historical or sentimental value of a specific piece of property even under new ownership.
Does an Encumbrance Make a Property Harder to Sell?
The short answer is no; an encumbrance does not necessarily make a property harder to sell. There are so many types of real estate encumbrances, some of which are so common that practically any piece of real estate will have at least some. Having a so-called “clear title” is not a requirement for a successful transaction.
Having a “clear title” refers to the parcel having a marketable-title, or a title where there are no encumbrances so severe that another party could have a claim to the entire property.
At the same time, it is essential to remember that not every encumbrance will have the same impact on a property’s valuation, marketability, and usability.
Some are minor cosmetic agreements or allowances for access to certain areas. However, others may severely limit an owner’s ability to build and improve the property or put it to the use they intend for it. Others may directly restrict an owner’s financial or legal ability to sell at all.
When considering encumbrances in a real estate transaction, it will help all parties to know that an encumbrance isn’t necessarily a problem, but not all encumbrances are created equal.
Know Your Encumbrances
Whether as a buyer, seller, or long-term homeowner, it behooves all real estate investors to understand encumbrances and how they impact their investment.
When you’re buying, you want to know what you’re buying and its limitations. While you own, you want to see what you are legally and financially permitted to do with your asset. And if selling, it’s best to know what you’re putting on the market and your limitations in transferring it to a new buyer.
Many of these will reflect minor regulations, agreements, and financial obligations. However, it’s important to remember that some can significantly affect your investment. They can help you improve your analysis and become a better-rounded, more savvy real estate investor.
It is not always possible to find every encumbrance on a property. To help deal with this problem, title companies offer a title insurance policy. These policies protect the insured from loss due to a claim or encumbrance. The most dramatic example is where another party claims they are entitled to property ownership through an illegal sale or transfer in the past.