Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Lien

What it is:

A lien is a lender's claim against a collateral asset that may be legally sold should the borrower fail to repay a loan.

How it works (Example):

When someone takes out a sizeable loan, such as a home mortgage or an auto loan, the lender often requires an asset that can be held as collateral against the loan. Thus, the collateral has a lien placed upon it. In the event of non-payment on the part of the borrower, the lending institution can exercise the lien and sell the collateral asset to offset the unpaid loan. Once the loan is repaid in full, the collateral asset is returned to the borrower and the lien dissolved.

To illustrate, suppose someone takes out a $10,000 loan for a new car. As part of the loan's terms, the bank gets to hold the title to the car as a lien against the car until the loan is fully repaid. Should the borrower, at any point, default or refuse to repay the balance of the loan, the bank can use the title to the car to sell it in order to recover the money that was lent.

Why it Matters:

A lien protects lenders in the event of non-payment. Since loans with collateral are less risky for the lender, they can lead to lower interest rates for the borrower.

When purchasing a used car, for example, it's important to check for liens against the vehicle. If there is an outstanding debt on the car, the buyer runs the risk of having it repossessed by the lender.

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