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Encumbrance

A restriction on the use of funds or a certain property

What is an Encumbrance?

An encumbrance is a restriction on the use of funds. It is used in public accounting to make sure that there are sufficient funds to meet certain obligations. Governments use encumbrances to avoid overspending on their finances. An encumbrance certificate is also used in real estate when there is a claim against a property. For example, it is used when there is a tax lien on the property, making it difficult to transfer it to the owner. The encumbrance restricts the policies that the property needs to abide by such as zoning laws or certain types of construction on the land.

 

Encumbrance
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What is an Encumbrance Certificate (EC)?

An encumbrance certificate (EC) is mostly used in the real estate industry and provides confirmation that a property is not subject to any monetary or legal obligation such as an unpaid loan or other liabilities. The EC is an important document for the homeowner as it is proof of legal ownership of the property and also allows the owner to take out loans from banks against the property.

The encumbrance certificate is secured from the local registrar’s office and usually contains all the transactions relevant to a specific period of time. Moreover, the certificate only provides information on documents that are registered with the registrar’s office. Hence, documents such as short-term lease deeds or testamentary documents will not be included in the transactions on the EC as the documents are not registered under the law.

 

How to Obtain an Encumbrance Certificate?

The encumbrance certificate can be obtained by the property owner at the local registrar’s office. The owner needs to provide relevant information about the property such as proof of address and title details, and settle the fee for securing the certificate. The officer will examine the index for the transactions pertaining to the property for the specific period.

An encumbrance certificate listing all the details of the transactions for a certain period is then issued to the owner. If there are no transaction details associated with the property, a nil encumbrance certificate is provided.

 

Types of Real Estate Encumbrances

An encumbrance is a restriction on the property, i.e., the owner cannot transfer the title to someone else. Here are some of the most common encumbrances that can be placed on a property:

 

1. Lien

A lien is the most common type of encumbrance, and it can be placed on a property to receive a financial obligation from the homeowner, i.e., a mortgage. The lien remains on the property until the mortgage is fully paid. It can also include tax liens for unpaid taxes.

Additionally, a contractor can have a lien when they have not received payment for repairs done to the property. If the lien is not satisfied, it can lead to the foreclosure of the house with the proceeds of the sale going towards the payment of the owner’s debts.

 

2. Deed restriction

It is an encumbrance placed on the land the property is on. It places a restriction on what cannot be done to the property and is also known as a restrictive covenant. The restriction can be anything from placing a satellite on the roof to where cars can be parked or even limiting the construction of anything on the land.

Deed restrictions help create a standard for what the property can be used for and to protect the value of the property. The restrictions are usually placed on properties with historical significance.

 

3. Easement

An easement gives the person or entity to use the property even though they don’t own it, i.e., a factory can place power grids on the premises. It can also be used for properties that are right next to each other.

For example, an easement gives one property owner access to the property of the owner next to them. It is required when a common walkway leads to the beach, but it is cutting into one owner’s property. The easement is placed on the land and not on the property itself.

 

4. Encroachment

An encroachment exists when a section of one property extends over to an adjacent property. It can include a fence that is built along the adjacent property or a tree branch that hangs over the neighboring property. Usually, the property owner may want the encroachment to be removed, as it often makes it hard to transfer the property title to the new owner.

 

5. License

A license is a right to use another person’s property. The license often comes with rules that need to be followed, and failure to abide by such rules can result in the being revoked. For example, a license can be obtained to host an event on a property.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Commercial Real Estate Broker
  • Homeowners’ Association
  • Project Finance – A Primer
  • Real Estate Development Model

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!