What is an Encumbrance?

An encumbrance is a restriction placed on the use of funds. The concept is most commonly used in governmental accounting, where encumbrances are used to ensure that there will be sufficient cash available to pay for specific obligations. By using encumbrances, a government entity can be assured that it will not over-extend its finances. A downside of encumbrances is that they increase the complexity of government accounting to some extent.

Characteristics of an Encumbrance

The key characteristics of an encumbrance are as follows:

Restricts property use or transfer. Encumbrances often impose limitations on how the property or asset can be used, modified, or transferred. Examples are zoning restrictions, easements, and liens.
Reduces property value. The presence of an encumbrance can lower the market value of the property, as it introduces potential complications or obligations for the owner.
Non-ownership interest. An encumbrance does not grant ownership rights to the holder but rather creates a legal interest or claim on the property.
Attached to property. Certain encumbrances, such as easements or covenants, are attached to the property and remain in effect even if the property is sold or transferred to a new owner.
Legal and binding. Encumbrances are legally enforceable and must be resolved or acknowledged in compliance with applicable laws and agreements.
Requires disclosure. When selling or transferring a property, any existing encumbrances must typically be disclosed to potential buyers to ensure informed decision-making.
Can be temporary or permanent. Some encumbrances are temporary, such as a mechanic's lien that is removed after payment. Others are permanent, such as an easement that grants access to a specific party indefinitely.
Recorded in public records. Many encumbrances, like mortgages or liens, are recorded in public records to provide notice to potential buyers or other interested parties.
Protects specific interests. An encumbrance often serves to protect the rights or interests of a third party, such as creditors, neighboring property owners, or government authorities.
Can impact financing or sale. Properties with encumbrances might face challenges in securing financing or completing a sale, as lenders and buyers typically prefer unencumbered titles.

Real Estate Encumbrances

The encumbrance concept is also used in real estate, where it is a claim against a property. For example, there may be a property tax lien or mechanic’s lien on a property. These encumbrances can usually be found in the records of the local county recorder or land records office. An encumbrance can also restrict the uses to which property can be put, such as zoning laws that limit the types of construction on a plot of land.

It is difficult to transfer an encumbered property, so the property owner has a strong incentive to settle the underlying claim.