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What Is an Encumbered Asset?

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Last editedAug 20212 min read

Is it possible for more than one party to own the same asset? In the case of encumbered securities, the answer is yes – with certain conditions. Before you purchase any security with conditions attached, here’s what you need to know about asset encumbrance. We’ll also discuss how these types of securities differ from unencumbered assets below.

Encumbered assets explained

Encumbered assets include any security that can be sold to a new owner while another owner retains some form of legal claim. Common encumbered assets examples include properties with a lien placed on them. If the property’s original owner was unable to keep up with mortgage payments, the asset retains the outstanding debts still owed to creditors. As a result, the lender places a lien on the property that is still there even after it’s been purchased by a new owner. This type of situation is also commonly seen in the stock market, where a broker could encumber a margined investment account awaiting an investor’s margin call.

Legally, asset encumbrance involves a claim filed against a property by a separate party. There’s a danger of encumbrance whenever a loan involves collateral because this means that if the borrower defaults, the secured lender holds certain legal rights over the asset in question. By contrast, an unencumbered asset is free from any conditions or legal obligations to another party.

How do encumbered assets work?

Encumbered assets are more often seen with secured rather than unsecured loans. With a secured loan, the borrower takes control of the asset and makes loan repayments with the understanding that the security can be taken back by the lender if the borrower defaults on the loan.

This means that if default takes place, the borrower gains legal ownership and title of the asset, but the bank lien will still stay on record. The asset can be sold to another party, but that lien will be transferred along with the titles, making it an encumbered asset.

There are several ways to handle this issue. In some cases, the lender will require full payment of outstanding debts before transferring ownership. The buyer and seller will both need to approve any deal as well as the lender. It’s often possible to work out a mortgage deal that includes the outstanding debt amount on top of the usual sale price.

Encumbered assets examples

While we’ve primarily discussed encumbrance in relation to real estate, you can find additional examples in brokerage accounts. For example, imagine that an investor owns shares in Company XYZ. He wants to borrow money, using the stock as collateral for the loan. This would make the shares encumbered assets because they’re now tied to loan repayments. The lender can set certain restrictions on the sale of the shares. For example, the investor might not be able to sell them until the loan’s been repaid, and if he defaults on the loan the lender could take possession of the shares as compensation.

Difference between encumbered and unencumbered assets

Whether you’re purchasing shares or property, you’ll have the choice between encumbered and unencumbered assets. The primary difference between encumbered and unencumbered assets boils down to whether or not they have additional legal restrictions attached to them. While an encumbered security might be attached to debts and liens, unencumbered assets are free from any such baggage. This makes them far easier to transfer between buyer and seller, without any third parties involved. Additionally, there won’t be any minimum sale price set by the lender.

It’s important to understand how encumbered and unencumbered assets both work before you take out any secured loan. While it may be tempting to get a good deal on a foreclosed house, the legal attachments can often be more trouble than they’re worth.

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