Encumbrance

An encumbrance occurs when a non-owner imposes financial or non-financial liabilities on a property. The owners hold legal possession of the property and can use it. But till the claims are settled, the owners are restricted from renovation, sale, and transfer of ownership.

Encumbrances are claimed when legal owners mortgage a property, fail to pay statutory governmental dues, fail to repay loans sanctioned against property, or breach a property's terms of the contract. The provision ensures that buyers get properties clear of all obligations. Also, it allows the use of a property without owning it; this is known as a license.

• An encumbrance is a financial or non-financial obligation made over a property by a non-owner.
• The provision restricts owners in the following ways—encroachment, easement, mortgage, lien, restricted covenant, and license.
• An encumbrance certificate (EC) is issued by the state's local registrar. It reflects all the monetary and non-monetary claims on the underlying property.
• A non-encumbrance certificate (NEC) is issued if no transactions are found related to a property, i.e., the property holds a clear title.

An encumbrance restricts an owner from freely making changes to the property. The underlying property can be real estate or land. It affects the property's title. Buyers cannot get clear titles till the sellers pay off outstanding dues on properties. It also impacts the value of a property.  Buyers negotiate for a cut-price if the title is disputed.

In order to transfer property, the owner has to get the claimant's permission or has to clear outstanding liabilities. Also, owners are restricted from renovating encumbranced properties unless the debt holders consent. The liabilities could be either financial or non-financial. The financial obligations include mortgage loans or liens. Non-financial obligations include easement, encroachment, and licensing disputes.

Taylor owns a building; the property tax was unpaid for the last two years. Hence, the municipal corporation sent a notice to Taylor. The notice warned Taylor that his building would be sealed unless he paid off outstanding property taxes within fifteen days. In this case, non-payment of taxes is the encumbrance of the property. Now, Diana is interested in purchasing Taylor's building. But the title of the building is not clear. As a result, Taylor cannot sell to Diana till he pays off all the outstanding taxes.

Following are the different types of encumbrances:

#1 - Easement

An easement restricts owners from additions, renovation, or sale of a property. Renovations changes could harm other parties who are legally permitted to use it for particular purposes.

For example, Jack and Simon have shops next to each other developed by a single builder. They have shared parking which is divided equally. If Jack decides to sell his shop, Simon can intervene to ensure that he is not deprived of parking.

#2 - Encroachment

Encroachment refers to one party intruding or disturbing property belonging to a second party (especially a neighbor). This happens during renovations.

Let us look at an example. Alisha and Brendon are neighbors. Bredon planted some mango trees in his backyard, but the branches of the trees spread across Alisha's backyard. Alisha used those mangoes reluctantly. Clearly, the protruding branches were a nuisance to Alisha.

#3 - Lien

A lien gives creditors the power to seize property when the owner cannot clear the debt. For example, the government seizes property if the owner cannot pay property tax and other dues.

#4 - Mortgage

A mortgage is a lien that arises when the owner offers property as collateral. Hence, the owner must clear all loans before selling.

#5 - License

A license is the right to use others' property. This right is subject to certain limitations and conditions. If the user breaches these terms, the owner can take back the underlying property and cancel the license.

#6 - Restrictive Covenant

It is also known as a deed restriction. Owners use restrictive covenants to impose dos and don'ts on the occupants. The restrictions are to be followed rigidly.

For example, a landlord leases a property with specific rules. The landlord forbids the leasee from renting the property to a third party.

An encumbrance certificate (EC) is a legal document. It lists out all the executed transactions concerning the underlying property. It is to be obtained from the state's local registrar. An EC is given to the owner after verifying proof of address, the property's legal papers, certificates from banks, and certificates from government authorities.  

A non-encumbrance certificate is a legal document which states that the underlying property is free from any legal obligations. Banks demand this document before sanctioning home loans.

When buyers show interest in some property, they demand a non-encumbrance certificate to verify the title. EC is important for the following reasons:

• An EC is reliable evidence of ownership and title. It discloses any monetary or non-monetary liabilities.
• It helps buyers negotiate prices if debts or obligations are found.
• The debt holder gets the preference at the time of sale. The proceeds from the sale of an encumbranced property first go to the debt holder. The title is transferred only after clearing the debts.

This has been a guide to what is Encumbrance and its definition. Here we explain encumbrance types, importance, examples, and certificate (EC). You may learn more about financing from the following articles -

• Lien Sale
• Tax Lien
• Fixed Rate Mortgage
• Offset Mortgage