What is an encumbrance in real estate? Simply put, it's anything that limits free ownership and the right to use a property. Encumbrances can come in all shapes and sizes - from liens and mortgages to easements and zoning restrictions. As someone looking to buy a property, understanding encumbrances is crucial because they can affect your rights as a property owner, limit what you're able to do with the property, or even make it difficult for you to sell down the line.
In fact, there was a Standard & Poor’s Ratings Services study during 2006-2010 on US residential loan losses. It indicated that defects related to title problems caused at least one-third of foreclosures during this time frame. Here we will delve into what encumbrances are in real estate, along with examples of types commonly found; read on for more information!
What Is an Encumbrance in Real Estate?
An encumbrance is a claim, charge, or liability that can affect the title of the property and limit your ownership rights. In simple words, it is a kind of limitation on the usage of the property—what you can or cannot do with it. Also know that, it’s usually on the property and not the owner.
Some common examples of encumbrances include mortgages, liens, easements, and restrictions that governments or homeowners' associations impose. These regulations may prevent you from using a particular portion of the land or securing financing.
It's essential to conduct a thorough title examination before purchasing any real estate - as an encumbrance could derail your investment plans entirely. In fact, 21% of all failed transactions in 2020 were due to issues found during the title search process.
Common Types of Encumbrances
Encumbrances come in various types and can affect the ownership rights of real property. Two primary categories divide these constraints - Financial encumbrances and Non-Financial encumbrances.
1. Financial Encumbrances
Financial encumbrances involve money-related claims on a property. It directly affects the owner's ability to sell or transfer ownership without paying off debts or satisfying judgments.
Liens
Liens are typically placed on properties when owners owe creditors, such as contractors, utility providers, and taxing authorities. These unpaid bills need to be settled before they can sell their assets for profit.
Mortgages
Mortgages usually apply in situations where a buyer borrows funds from a lender, like banks or mortgage companies. They use the property as collateral until the debt is fully repaid with interest. These payments may often take several years!
2. Non-Financial or Legal Encumbrance
Legal encumbrance on property refers to claims based on laws rather than finances, which is obvious. Here are some interesting types that impact your ownership:
Easements
Easements express other people's right-of-way through your land. For instance, granting someone else permission to cross your lawn regularly by taking shortcuts is an easement.
Restrictive Covenants
These covenants restrict certain activities from happening entirely within particular locations. There are homeowners associations that often practice this method of control. It can be neighborhood council authorities imposing strict guidelines for residential homes like controlling the types of plants and colors used to achieve homeownership goals.
Encroachments
Encroachment means the unapproved entry of a structure or object onto another person's property. Suppose a bordering neighbor begins utilizing part of one's property without consent, and that disrupts the owner’s enjoyment. That’s basically a violation of the boundaries of the said property!
Leases
Leases permit exclusive use of portions that can easily be rented out, making investments valuable. This is especially true in the case of commercial buildings that are leased out for business purposes but remain under the ownership of another party.
Examples of Encumbrances
- When property taxes remain unpaid, the government can place a lien on your real estate. A buyer must settle any outstanding debts before completing a purchase. That’s a tax lien.
- Construction contractors and subcontractors typically file mechanic's liens when owners fail to pay for completed work or supplies used in their construction project. This situation leads them to file claims against land as well.
- Deed Restrictions, which limit how future owners can use the land or make improvements.
- Boundary disputes, where ownership rights have not been defined clearly. This typically results from prior agreements between neighbors' claimed overlapping areas.
- Environmental regulations established by public authorities could affect usage if it is deemed that an area may be considered hazardous due to toxicity reports.
Understanding what types of encumbrances exist is one thing. But knowing precisely how they pertain to individual properties ensures better decisions during purchases.
How to Find Out if a Property is Encumbered
Before investing in any real estate, it's crucial to verify if the property carries any encumbrances. Otherwise, your ownership rights might get hurt, or you may experience a significant increase in your costs. Here are some ways to check for encumbrances:
Title Search
Performing a thorough title search at the county recorder's office can help you identify any potential liens on the property. That includes unpaid taxes, unreleased mortgages, and other claims against the title from previous owners.
Property Survey
A professional survey can measure and ensure the accuracy of property boundaries. It will help identify easements on an individual piece of land. But, this procedure also maps various potential defects, like high voltage lines running over your house. It might lead you to think again about buying this particular piece of land.
Consulting with Real Estate Attorney
It’s always good to get legal advice from professionals who have in-depth knowledge about these proceedings. A real estate attorney will assist in performing full evaluation checks before acquiring real estate. They will perform thorough research into key documentation factors, including deeds that confirm the limits of legal ownership.
Risks of Buying an Encumbered Property
It's essential to be cautious when buying a property because the value of the property can be impacted if it is encumbered. Here are some of the risks you should look out for.
Financial Risks
If you purchase an encumbered property, there can be numerous financial implications that may harm or impact your investment return. For instance, having apparent defects like liens and mortgages and unpaid taxes already charged by its previous owner will lead to legal battles, resulting in a huge financial loss that might even exceed your original investment sum.
Legal Risks
Legal risks are also involved when buying such properties. For example, if there are outstanding taxes or liens against the property, the buyer needs to repay them before the transfer of ownership can proceed. Buyers who fail to do proper research into any existing claims against a home, run the risk of losing money and wasting time pursuing legal solutions in court.
What to Do When a Property is Encumbered?
Encumbrances in real estate can sometimes cause complications for you as a buyer. So you should know what to do when you’re interested in purchasing an encumbered property.
Here are 4 steps that will guide you:
Step 1: Identify the nature of the encumbrance
Determining whether it’s a lien, easement, mortgage, or any other type of binding agreement is key before making any purchase offer.
Step 2: Review and understand all related documents
Before you proceed with negotiations and potential sales offers, you need to gather all relevant information about any existing claim from public records.
Step 3: Evaluate financial capacity and prepare for added expenses
There are necessary charges for resolving issues relating to past payments. These might come up as part of acquisition costs. Don’t forget to consider the legal fees incurred during the negotiation process.
Step 4: Negotiate terms within your limits
When it comes to re-negotiation, it's important to stay within the established parameters so that you avoid any negative impact on profit margins. Do seek expert advice on contract clauses related to earlier debt issues before finalizing deals involving properties - the ones with a history of disputes among former owners.
Final Thoughts
If you're thinking of buying a property, it's important to understand encumbrances. They can impact ownership and usage rights, limiting the property's value and marketability. Financial and non-financial encumbrances such as liens, mortgages, easements, or leases can be involved. It will help if you seek professional advice before investing in any real estate property.
Excelsior Real Estate is here around the beautiful Lake Minnetonka and surrounding places for excellent real estate opportunities. We offer expert guidance for a smooth transaction with no hassle from potential risks regarding your investment potential on Minnesota properties! Contact us today for comprehensive services that will make informed decisions about purchasing real estate easier!
