Understanding Encumbrances in Real Estate
When you purchase real estate, be it for investment purposes or as a primary residence, problems such as structural defects and insect infestations may be visible to you.
When you purchase real estate, be it for investment purposes or as a primary residence, problems such as structural defects and insect infestations may be visible to you. However, some are not as obvious but could result in a greater impact. This could be a property that comes with encumbrances.
In real estate, encumbrances encompass a wide range of financial and non-financial claims made against the property by parties other than the title-holder. These encumbrances could come with legal obligations that hinder or restrict the use or transfer of a property, preventing the property owners from enjoying the full control over their property, that is, unencumbered control.
How do encumbrances affect the title?
Depending on the types of encumbrances registered on a title, it may restrict the owner’s ability to transfer the property and limit its free use.
Under certain circumstances, the creditors or governments may seize or reclaim the owner’s property. Furthermore, titles can become unmarketable if they are subjected to encumbrances such as easements or liens. Although it does not necessarily mean the title cannot be acquired and sold, the buyer may still cancel the sale, despite having signed a contract. It is even possible to seek damages. As for other encumbrances, such as environmental regulations and zoning laws, they are less likely to affect a property’s marketability. However, they can prevent certain uses and improvements for the property.
What are the different types of encumbrances?
The following are some examples of encumbrances associated with real estate:
Easements allow one party to exercise rights over another person’s property, such as the right to utilise or improve portions of another party’s property or to prevent another party from doing so. This easement could be positive or negative.
A positive easement permits a party to do something on the other’s property. For example, pedestrians might have the right to use a footpath passing through an owner’s property. In contrast, a negative easement prevents the owner of a property from exercising one of his rights. For instance, a property owner might not be able to construct a structure that would block the neighbours’ light.
A mortgage is a method of securing a loan payment where the owner, who is also the borrower, transfers title to the creditor, but on condition that the title must be re-conveyed when the loan and interest are fully paid. If an owner fails to repay his mortgage, the lender may seize the property as collateral and foreclose.
A lien is an interest on a property secured by debt. In the event that the owner does not repay the debt, the lienholder is entitled to liquidate his property (normally through a court sale) and use that as collateral. Such an encumbrance can affect the title of a property. As a lien is attached to a property and not its owner, if the owner wishes to sell his property, he must resolve the lien to give the buyer a clear title.
The most common liens are mortgage liens, tax liens, mechanic’s liens, and judgment liens.
An encroachment occurs when a party intrudes on or interferes with an adjacent property that belongs to another party. Often, they are discovered as part of a physical inspection of the property or during a survey in the process of selling.
In some cases, neighbours may encroach by accident, such as constructing a retaining wall across the property line or when an overgrown hedge intrudes into the neighbour’s property. Even so, it is not uncommon for neighbours who do not get along to encroach on each other’s property intentionally.
A property owner may hire a professional land surveyor and resolve the encroachment issue with his neighbour. However, if the owner plans to sell his property before addressing the encroachment, he must disclose it to the buyer. Any encroachment can delay a sale and thereby lower the value of a property.
Leases are agreements between two parties to rent property at an agreed-to rate, for an agreed period. The lease agreement constitutes an encumbrance because the property remains under the lessor’s name, but the lessor’s right of use is severely limited.
Read also: What is a Lease Option?
Read also: What is a Lease Purchase?
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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.