Few homeowners buy their home in cash. Rather, most work with a bank to obtain a mortgage. The mortgage uses the property as collateral to the bank; if the homeowner fails to pay back the loan, the bank can foreclose on (sell and repay itself using the proceeds from) the property. In other words, the bank has a legal interest in “your” property until your loan is paid off.
Now, imagine that you’ve been in your home for several years. You decide that the kitchen needs a little sprucing up. So you hire a contractor to renovate the old kitchen for a lump sum of $10,000. Unfortunately, a dispute develops between you and the contractor. She says that you still owe her $2,000 for extra work that was required, even though you paid the full contract amount. You disagree. She files a mechanics' lien on your home.
How might the existence of the mechanic’s lien affect your mortgage? Will the bank receive notice of the lien, and if so, what will it do about it?
Mortgages are common lending tools in which the borrower/homebuyer puts up the title to property as security (or “collateral”) for a loan in order to buy the real estate. The borrower typically agrees to make regular payments of principal and interest to repay the loan to the bank. If the borrower stops paying (“defaults”), the lending bank can foreclose on the property in court, and then sell the property to pay off its loan.
Mechanic’s liens are tools that help contractors, subcontractors, and suppliers (and sometimes architects and engineers) make sure they receive compensation for work they performed to improve or repair real property.
The liens serve to show a legal interest in the property, and are filed on the property’s public docket. Unlike lawsuits, liens are fairly short documents, generally just a few pages long.
While the specific requirements vary from one jurisdiction to the next, the lien will ordinarily state the name of the lienor/company, the name of the homeowner, the address, the services performed or materials provided, and the amount of money still due and owing.
Mechanics' liens become a cloud on title. Any potential buyer would be able to see that your property is encumbered by a lien, and would insist that you settle with the lienor and have the lien removed before that buyer takes your land (and becomes subject to the lien). For the same reason, liens are an impediment to refinancing a home, since a bank would look closely at the property records upon an application for refinancing.
For all of these reasons, mechanic’s liens are a burden to homeowners.
Returning to the example above, in which a dispute emerged between you and your kitchen contractor, you may wonder whether your bank will even find out that a lien has been filed on your property.
Anyone can walk right into the clerk’s office and receive a listing of the persons or entities that have an interest in a particular parcel of land (though some fees might apply). This would include a mortgage filing listing your lending institution. It would also include any deeds on file, as well as any liens.
So, in theory, your lending bank could quickly discover that a mechanic’s lien has been placed on your property. In reality, however, it is unlikely that your bank is frequently monitoring the title dockets. They are not centralized, or even electronic, throughout much of the United States. In other words, if the bank is not sent a copy of the lien, it is somewhat unlikely that your loan officer will discovery that it was filed.
The next question is, will the mechanics' lien be sent to your bank? The answer to that depends on your jurisdiction.
While all 50 states have some version of a mechanics' lien law, each states' law is very different. In some states, lienors are required to serve their mechanic’s lien on all parties with any interest in the property. That is, the lienor would be required to do a title search and serve all entities with an ownership interest, including a bank or lender, and file an affidavit swearing to such service before the lien could be valid. In other states, a lienor might need only to serve the homeowner before filing the lien.
Assuming your bank does, indeed, receive notice of the lien, how might this affect your mortgage? Will your rates or interest increase? Here, the answer will depend on your state, your bank, and the specific terms of your mortgage.
For example, your mortgage might actually include a provision that requires you to remove any lien that is filed on the property within a certain number of days.
There are several ways to remove a mechanics' lien from property. These include: (i) settling with the contractor in exchange for a lien discharge and release; (ii) filing a bond to cover the amount of the lien; or (iii) filing a lawsuit against the contractor seeking removal of the lien. All three of these options, unfortunately, involve you spending some money, whether for settlement payments, procuring a bond, or legal fees.
Each state has different rules regarding the priority of interests on real property. In some states, the bank’s interest in the property will have priority over the interests of the lienor. This priority gives it the right to be paid before the contractor.
However, some states like Indiana and California have statutes that specifically permit the lien to “relate back” to when the work represented by the lien was performed. For example, imagine that an architect did some initial work to design a house, but was never paid. You take out a mortgage, buy the property, and build the house that as designed. Then, the architect files a lien. The architect could argue that he or she should have priority over the bank, because the work came before the existence of the mortgage instrument, even though the lien was filed later. To determine the applicable laws on priority in your state, talk to a real estate attorney, particularly one with a specialty in foreclosure.
Even if your bank does not contact you about the existence of the lien, or require you to pay higher interest rates because of it, it is still in your interests to rid your property of the lien. Remember, you will struggle to sell or refinance your property if it is encumbered by liens. Thus, the property is essentially worth less to you. Although it depends on the particular facts of the situation, most homeowners will find that settling quickly with the contractor is the easiest approach when it comes to dealing with the frustrations of a lien.