Topics:Business Loans 101
A lien is a legal filing giving a lender the right to your property or other assets if you fail to repay a loan on time or in full — or both.
Essentially, a lien is a protection for the lender.
Think about it this way: It is risky to lend money without knowing if you’ll get it back. When someone borrows money from a lender, the lender needs some kind of insurance that the chance they take on a business won’t result in their own financial demise.
If the lender has secured the loan with a lien and you don’t make your monthly payments, the lender can sell the assets you’ve put up as collateral to cover their loss. Another example of default would be borrowing more than agreed upon in the contract.
Liens can apply to a mortgage, a personal loan, or any other loan type. Besides promising assets to the lender, a lien also prevents the borrower from selling or transferring the pledged assets without first paying off his or her loan. For example, if someone pledges their house as collateral, they cannot sell their house without first paying off their loan.
The contract that legalizes a lien is called a "lien letter" or a "letter of set-off.” This letter, signed by both the lender and the borrower, signifies that the borrower gives up their rights to their assets if needed.
In a business loan setting, lenders file Uniform Commercial Code (UCC) liens, also referred to as UCC filings, with their respective state secretaries of state when a borrower takes out a loan.
A lien can be placed on specific items of collateral.
A personal lien can be placed on the following:
A business lien can be placed on the following:
While specific collateral liens place limitations on what a lender can take, a blanket lien gives the lender authority to seize and sell any and all business assets if you stop making payments on your loan. Blanket liens give the lender more power than specific collateral liens.
For example, if I pledge my home equity, that is what the creditor takes if I default. However, if a "blanket" lien is agreed upon, this means that the creditor can take possession of business assets in general. Blanket liens can become complicated legally if a business owner defaults because of the court process involved in determining what business assets the creditor can and cannot seize.
Another type of lien relevant to small business loans is a tax lien. The federal government via the Internal Revenue Service (IRS) or a state tax agency can issue a tax lien against a business or individual for unpaid taxes, including income tax or sales tax.
To remove a lien, you have two options:
A business can have multiple UCC liens filed against them at the same time, but the lender who files the first lien has first claim to a business’s assets if they default on their loan. Therefore, some lenders choose not to loan to businesses with existing UCC liens.
You may be able to get the existing lienholder to verify you’re making good on your debt if you’re making regular payments toward the full amount. This can help your case if you need to take out additional funding with a different lender.
UCC liens are required by most lenders as a routine part of small business financing so you’ll have a hard time avoiding a lien if you’re taking out a business loan. But as long as you repay your debts and don’t default on your loan, a UCC lien won’t impact your credit score.
However, tax liens can lower your credit score and impact your chances of future loan approval, so prioritize being up to date with your tax-related documentation and payments each year.
Sometimes, instead of (or in addition to) a lien, a lender will have you sign a personal guarantee, pledging your personal assets to repay a loan if your business entity can’t.
But the most important thing you can do is to understand the personal and business assets you’re putting at risk (via a lien or a personal guarantee) before signing any loan agreement, and only pledge the assets you can be prepared to lose. Ask your lender if they require a personal guarantee or collateral and if they file a lien on borrowers’ assets.
Then make a plan to pay back the loan on time and in full.
July 22nd, 2022
July 22nd, 2022
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