When you're ready to buy your first home, there's a lot to consider - and learn. The financial terms, alone, can be very confusing. That's why it's best to learn all you can before you start the process, so there won't be any surprises. Two terms that are bandied about are mortgage and lien, and it's very important to know the difference.
Just What is a Mortgage?
Definitively speaking, a mortgage is a loan. That's when an individual or lender gives the borrower money but expects it to be paid back. Along with that, they want something for their trouble, which usually comes in the form of interest - or a percentage of the loan amount factored into the repayment.
So What is a Lien?
A lien is legal claim on an asset. It can be part of the mortgage process when one (a lien) is placed on a property in a secured loan. In the lending process, this legal claim states that when a borrower seeks a loan to buy property, the lender has the legal right to take that property and liquidate it to ensure they recover the amount of money borrowed.
Different Types of Loans
There are two different kinds of loans - secured and unsecured.
Unsecured: A good example of an unsecured loan is a credit card. A bank issues the borrower a loan that's paid back with a higher interest rate. That higher rate stems from the fact that the borrower doesn't guarantee the loan with collateral. Instead, the borrower's ability to make payment is the collateral.
The exact rate of interest a borrower is charged depends on two factors:
- Their credit rating, which forecasts the likelihood of their ability to pay an unsecured loan
- The lender's predatory nature. Some companies that issue credit cards place liens on their unpaid balance, meaning they put themselves in the position of recovering the amount owed to them once the asset - or credit card account - is liquidated.
A personal loan can be either a secured or an unsecured.
Secured: With a secured loan, the lender assesses the borrower's financial assets, such as checking and savings account, as well as their 401k. That's because these are valuable and can be considered collateral. The borrower lists these assets in their loan application. Before signing the application, the borrower should make sure this doesn't mean the borrower is placing a lien on these assets.
An example of a secured loan is a mortgage. In this type of loan, the value of the property the borrower intends to purchase becomes the collateral. That means if the borrower defaults in payments, the lender is repaid with liquidation of the property.
Additional entities can place liens on property to recover defaulted payments. Such cases include car loans, unpaid credit cards, and even federal income taxes to name a few.
When a borrower has a co-signer, that party agrees to be responsible if payments aren't made. But if a borrower defaults in payments, the lender could place a lien on the co-signer's assets in order to recover their funds. This often takes place when the lender takes the borrower to court, arguing the money owed, and the court grants the lender a lien against property owned by the co-signer to satisfy the case.
An example of this type of situation would be when a person owes a landscaper for work they provided but the person doesn't pay because of a dispute. To recover their money, the landscaper goes to court to put a lien on the person's property or other asset the court allows.
Once you know the difference between a mortgage and lien, you're better equipped to move forward with the home-buying process.