Consensual Liens

April 13, 2006

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Of the different types of liens, these are liens to which you voluntarily consent, as a result of a loan or other advance of credit. A homebuyer consents to a bank taking a security interest in the home when a mortgage is obtained. A security interest also is created when a car dealer arranges for financing for a car buyer. The property purchased secures the buyer's obligation to pay for the property.

Consensual liens include:

Purchase-Money Security Interest Liens. Here, the creditor extends credit to the debtor specifically for the purchase of the property that secures the debt. Examples include a first mortgage on a home, a car loan, and situations in which the seller finances the purchase of property, such as furniture, through a credit agreement.
Non-Purchase-Money Security Interest Liens. Here, the debtor puts up property he or she already owns as collateral for a loan. The loan proceeds are then used to pay expenses (or perhaps to buy other property). Examples include a second mortgage (or refinancing of a mortgage) on a home or a loan used to pay operating expenses with previously owned office equipment put up as collateral.

Both types of consensual liens are usually non-possessory, meaning the debtor takes, or retains, possession of the property. However, it's possible for either type of consensual lien to be possessory. In that case, the creditor takes possession of the collateral. A loan from a pawnbroker, for example, usually would create a possessory, non-purchase-money security interest lien in the collateral.

While this seems very straightforward, the type of debt can have a large impact on the creditor's rights if a debtor defaults. The rules vary from state to state, but characteristics of a debt are critical to understand if assets are to be protected. Issues include:

Who is holding the property that secures the debt: the debtor or the creditor? In a car loan, the debtor has possession of the property. When a loan is obtained from a pawnshop, the creditor has possession of the property securing the loan.
Was the debt incurred to purchase property or not? For example, a first mortgage loan is a purchase money loan since the proceeds were used to purchase a residence. In contrast, a refinancing loan is not a purchase money loan. The homeowner already owned the property.
What are the characteristics of the property purchased? This is often the essential inquiry when it comes to asset protection. The states, as well as the federal government, have a wide variety of laws relating to what assets are protected from creditors and how they are protected. The primary mechanism for protecting selected assets is a concept called exemptions. In essence, the law may declare that certain property simply cannot be seized by a creditor.

For many people, the most important exemption is the homestead exemption. This protects part or all of the value of a residence from creditors other than lenders holding mortgages. Each state has its own rules. Some protect the residence fully; others provide little or no protection. Other types of property that might be protected are personal items and business tools of the trade (for more details, see our discussion on effective asset exemption planning).

The other common types of liens include statutory liens and judgment liens.